A Study on Comparison of Readability Levels of Annual Reports of Banks on the Basis of Profitability.

Janglani, Silky ; Sandhar, Simranjeet Kaur

Introduction

1.1 Understanding Readability

Readability is what that explains some texts are easier to read than others. It is often puzzled with legibility, which concerns style and layout. Readability talks about the ease with which a text can be read. Numerous mathematical formulas have been developed to support writers in computing the readability of their script. Accepted readability indexes comprise the Flesch Readability Formula, Given by Rudolf Flesch; the Fry Readability Graph, formed by Edward Fry; and the Gunning Fog Index, created by Robert Gunning (Lewis and Adams, 2001).

George Klare (1963) describes readability as "the ease of understanding or comprehension due to the approach of writing." The inventor of the SMOG readability formula G. Harry McLaughlin (1969) describes readability as: "the extent to which a specified class of public find certain reading material convincing and understandable." This definition focuses the communication between the text and a class of readers of known character such as reading skill, prior knowledge, and motivation.

1.2 Readability Formulas

Developments and research on the formulas was something of an undisclosed until the 1950s. Authors like Rudolf Flesch, George Klare, Edgar Dale, and Jeanne Chall developed the formulas and the research supporting them and their application. During 1980s, there were 200 formulas of readability confirming to their strong theoretical and statistical legality. Research in due course established that the two factors commonly used in readability formulas-a semantic (meaning) variable such as difficulty of vocabulary and a syntactic (sentence structure) variable such as average sentence length-are the best interpreter of textual difficulty. (DuBay, 2004).

The Flesch readability formula is the most accepted measure for reviewing textual difficulty (Clatworthy and Jones, 2001).

1.3 Relevance of Readability in Corporate Disclosures

Corporate annual reports are widely acknowledged as tools used by companies to facilitate communication with investors and other stakeholders. These documents represent the primary source of information for investors and analysts for decision-making purposes. As such it is important that users are able to understand and comprehend the information contained within a company's annual report.

The importance of the corporate annual report stresses its potential to be influential. It can either be a good news communication highlighting superior corporate performance or a bad news communication relating sub-par financial results or corporate actions. Firms that veil negative information are missing an opportunity to gain trust and confidence (Subramanian et al., 1993). There are three significant elements of corporate disclosure: content (what), timing (when) and presentation (how) (Courtis, 2004), the worth of these three, is based upon their readability and understandability. Firms may influence the content and appearance of information in various ways, fundamentally using what is called as 'impression management' (Godfrey et al., 2003). Using the above practice, companies can manipulate oral information by the reading ease manipulation (e.g., to make the text difficult to read) or by the rhetorical manipulation method/practice (e.g., using persuasive language).

Still the area of research for readability of annual reports of Indian companies in connection with financial performance is been left out. The research work is an initiative to test the relationship of readability levels of annual reports of banking sector with their performance figures. Hence this study may reveal whether corporate communication in the form annual reports could reduce information asymmetry or not. If disclosure readability is strategically used by managers to hide adverse information, a relationship between firm performance and readability would be expected. The variable that represents the firm's financial performance is profitability. The study covers the annual reports of banking sector in India and compares the readability scores of these reports on the basis of profitability.

2. Review of Literature

Companies as well as the regulatory bodies are making efforts to increase the usefulness or the readability in particular, of the annual reports. One reason is that those who are preparing the annual report for the company may not be the best judges of clarity and readability. Another reason is that it is the nature of financial reporting to score in the lower third of the readability scale (Wheeler, 2006). Following are review of several studies done on the readability and its relevance on corporate annual report.

Gelb and Zarowin (2000) compared firms with high disclosure ratings versus low disclosure ratings and conclude that the former experience a more significant stock price association to current and future earnings reports, consistent with more credibility behind those disclosures. Kothari et al. (2008) used content analysis to show that positive disclosures reduce firm risk along multiple dimensions, including the cost of equity capital, volatility of a firm's stock returns, and the dispersion of analyst forecast estimates.

Clatworthy and Jones (2001) said the most common tool utilised in readability studies to assess the syntactical complexity of narratives has been the Flesch readability formula. In a calculation that considers the number of syllables per word and the number of words per sentence, the Flesch formula produces a score that can be aligned with reading difficulty. The lower the score, the harder the narrative passage is to read. The use of Flesch scores as a measure of the readability of annual report narratives has been criticised by several authors. But he argued that the use of the Flesch formula is justifiable because it allows for easily computable results, understandability, and comparability with previous studies.

Further evidence that firms strategically manage the information content of their corporate disclosures is found in the literature on earnings release timing. For example, Lurie and Pastena (1975) found 59 percent of "good news" disclosures are made during the first six-months of a fiscal year, while only 22 percent of "bad news" disclosures are made during this same interval. More strikingly, they also find 38 percent of all "bad news" filings occur during the final month of a firm's fiscal year. Similarly, Kross and Schroeder (1984) found early releases of quarterly earnings announcements are characterized by better news than late announcements, while Chai and Tung (2003) found late reporters exhibit lower profitability and are characterized by more negative discretionary accruals than their early reporting counterparts. Finally, both Patell and Wolfson (1982) and Damodaran (1989) reported firm's time of release of negative information to minimize market impacts.

Jones and Shoemaker (1994) fields of accounting, business management which study report narratives (26 or accounting textbook (3 assess the reading ease of the components. They reviewed of accounting reports reviewed 32 studies in the communication, and the readability of annual studies), tax law (3 studies), studies). Most studies try to annual report and its research into the readability concluding that studies have consistently shown that narratives in corporate reports are difficult or very difficult to read.

The above literature portrays a convincing association between disclosure efficacy (both quality and quantity) and annual report readability levels. Of interest to our study, therefore, is whether the readability of financial reports is empirically associated with performance after controlling for other "nonexperimental" sources of readability variation. In addition, the results of the study may also suggest a more detailed comparative analysis approach for studying readability levels of annual reports may well be worthy of exploration by future research. In sum, the results of the study should be viewed as a meaningful step forward toward a fuller understanding of the linkages between basis of comparison and readability levels of annual reports.

3. Objectives of the Study

1. To study the concept of readability.

2. To calculate the readability scores of corporate annual reports.

3. To compare the readability score of annual reports of banks on the basis of Bank's Profitability.

4. Research Methodology

4.1 Research Design

This study talks about readability of annual reports of banks. While it is our opinion that the use of readability formulas in accounting has stood the test of time, there is still considerable debate over the general applicability of readability formulas in the accounting context.

4.2 Population and Sample

The population consists of all banks whose financial year-end fell on 31st March. The population consists of 20 Public sector banks and 15 private sector banks. Annual reports of three years for the banks were taken for the study. Hence the time period of the study is from 2009 to 2012. Some of the annual reports were either not available or were not open for editing, hence they were removed from the scope of the study. The Banks were divided on the basis of the figures of median. Following are the details of the population:

Sample Banks of Public Sector

Banks - 20; No. of years - 3; Total Annual reports = 60; Not available or Unedited annual reports = 14; Total Annual reports = 46

Sample Banks of Private Sector

Banks - 15; No. of years - 3; Total Annual reports = 45; Not available or Unedited annual reports = 3; Total Annual reports = 42

Hence the sample size is 88 Annual Reports. The sample completely belongs to banking sector. The median values divide the sample in two groups for all the variables.

4.3 Data Collection

The annual reports for three years of all the banks taken up as sample were downloaded from the respective websites of each bank. The annual reports downloaded were available in Pdf format. All non financial information from these annual reports were copied and pasted in MS word document. Non Financial information includes Message from CEO, Director's Report, Management Discussion and Analysis, and Schedules containing non financial information, Auditor' s Report on Consolidated financial statements and Basel III Disclosures. All the heading items, paragraphs that have less than one line and tables were deleted. To determine the proper software to calculate readability score, initially work was started with MS Word's tool. Later help was taken from a website i.e. Test Document Readability (http://www.readability.info/) to analyze the characteristics of the annual reports, which ascertains a multitude of readability scores, such as Kincaid, Automated Readability Index (ARI), Coleman-Liau, Flesch Index, Gunning FOG Index, and Simple Measure of Gobbledygook (SMOG) Grading. Larger deviations were found between the results generated by MS Word and that of the website. Then some part of annual reports were randomly selected and Flesch Reading Ease Score was computed manually and it was found that the computed results of the website were more accurate. Finally, it was decided to use the statistics provided by the website.

4.4 Dependent Variables

Of a number of readability score methodologies, readability of annual reports are empirically measured using the following variables:

4.4.1 Flesch Reading Ease Formula

The first variable is the Flesch Reading Ease (such as the average number of syllables per 100 words and the average sentence length) in the annual report. The idea is that, everything else equal, more syllables per word or more words per sentence make a document harder to read and understand. The higher the Flesch Reading Ease, the easier is the text. Therefore, the readability score is represented by the formula is as follows:

Readability Score = 206.835- 1.015SL - 0.846WL

Where: SL = Average sentence length (Number of words/number of sentence) and WL = Average Word Length (Number of syllables/100 words)

This formula was chosen for the following reasons. First, it is the most widely used technique in previous readability studies (Courtis, 1986; 1998; 2004; Schroeder and Gibson, 1990; 1992; Smith and Taffler, 1992a; Subramanian et al., 1993; Smith et al., 2006). Secondly, due to the fact that it is a widely accepted method, it is possible to compare the findings with prior studies.

4.4.2 Kincaid Formula

The Kincaid Formula has been developed for Navy training manuals, which ranged in difficulty from 5.5 to 16.3. Flesch Reading Ease formula simplified and converted to grade level (now known as the Flesch-Kincaid readability formula):

Flesch Formula = (11.8 * syllables per word) + (0.39 * words per sentence) - 15.59, rates text on U.S. grade school level.

Fog Index

Similar to Li 2008, we measure the readability of annual reports using the Fog Index. This index, developed in the computational linguistics literature, captures the written complexity of a document as a function of the number of syllables per word and the number of words per sentence. Specifically, we calculate the readability of the annual reports for firm i in year t as follows:

Grade level = 3.0680 + .0877 (average sentence length) + .0984 (percentage of monosyllables).

Fog Count new: GL = (easy words + 3 (hard words)/(sentences))--3 / 2

Where:

* easy words = number of number of 1 and 2-syllable words per 100 words

* hard words = number of words of more than 2 syllables per 100 words

* sentences = number of sentences per 100 words

where a complex word is defined as one with three or more syllables. The formula is objective and simple to calculate.

The relation between Fog and reading ease is as follows: FOG >=18 means the text is unreadable; 14-18 (difficult); 12-14 (ideal); 10-12 (acceptable); and 8-10 (childish).

Automated Readability Index

The Automated Readability Index is typically higher than Kincaid and Coleman -Liau, but lower than Flesch.

ARI = 4.71*chars/wds+0.5*wds/sentences-21.43

Smith and Kincaid (1970) successfully validated the ARI on technical materials in both manual and computer modes.

Coleman-Liau Formula

The Coleman-Liau Formula usually gives a lower grade than Kincaid, ARI and Flesch when applied to technical documents.

Coleman-Liau = 5.89*chars/wds-0.3*sentences/(100*wds)-15.8 Smog-Grading

The SMOG-Grading for English texts has been developed by McLaughlin in 1969. Its result is a school grade. SMOG formula is in the belief that the word length and sentence length should be multiplied rather than added. By counting the number of words of more than two syllables (polysyllable count) in 30 sentences, he provides this simple formula:

SMOG-Grading = square root of (((wds >= 3 syll)/sent)*30) + 3

Independent Variables

Profitability = If disclosure readability is strategically used by managers to hide adverse information, a relationship between firm performance and readability would be expected. This management opportunism story argues that managers have incentives to obfuscate information when the current performance is bad (Bloomfield (2002). However, this hypothesized relation between disclosure readability and a firm's current performance may not be significant. First, corporate annual reports contain a lot of financial information about current and historical performance. Hence, the benefit to the managers of making the annual reports harder to read in order to hide adverse information about current performance seems small. Second, if the good current earnings are (partially) due to strategic manipulation, then managers may not necessarily want to make the annual reports easier to read when the reported earnings are "good". The earnings are defined as EBIT/Total Assets. Thus the hypotheses assumed are:

[H.sub.0]1 = there is no significant difference of profitability on the Flesch Kincaid Reading Ease score of annual reports of banks.

[H.sub.0]2 = there is no significant difference of profitability on the Flesch Kincaid Grade Level score of annual reports of banks.

[H.sub.0]3 = there is no significant difference of profitability on the Gunning Fog score.

[H.sub.0]4 = there is no significant difference of profitability on the SMOG Index score of annual reports of banks.

[H.sub.0]5 = there is no significant difference of profitability on the Coleman Liau Index score of annual reports of banks.

[H.sub.0]6 = there is no significant difference of profitability on the Automated Readability Index score of annual reports of banks.

Tools for Data Analysis

Independent Sample T Test--The Independent-Samples T Test procedure tests the significance of the difference between two sample means. Also it displays descriptive statistics for each test variable, A test of variance equality, A confidence interval for the difference between the two variables (95 percent or a value you specify).

Results and Interpretations

The hypothesis stated assumes that there is no significant difference in readability levels predicted by different readability formulas of annual reports on the basis of their profitability levels. The more is the score of Flesch Kincaid Reading Ease the easier is the report is to read. On the other hand rest scores assumes that the more is the score the harder is the report is to read. As the study covers the banking industry hence it can be said as the bank may be with higher or lower profitability but the difference in their level of readability and understandability is due to chance.

The table shows the descriptive statistics of all the readability scores, which has been divided in two groups on the basis of median of profitability of banks. The mean scores of all readability scores of both the groups do not have much variation. Also the values of standard deviation are low which concludes that there is not much variation in readability scores of annual reports of banks taken into consideration.

Thus it can be depicted that profitability levels do not show much difference on the readability levels of the banks belonging to different groups. Hence the annual reports of public sector banks are more readable than private sector banks.

Independent T Test produces two tests to compare the means of two groups divided on the basis cut point i.e. median of profitability. Levene's Test the variances of both the groups. As the significance value of Levene's Test in all the cases is more than .05 then the result of equal variance assumed holds true. If the significance value of T test is less than .05 then there is significant difference between the means of two groups. Here the value is greater than .05 in all the cases so there no significant difference and the variation are due to chance. Hence the hypothesis for public sector banks is accepted as the value of t test goes beyond the critical level. So the firms on different profit levels have same readability levels and profitability cannot be a basis of comparison for all kinds of readability scores.

The levene's test shows the significance value as more than .05 in the case of Flesch Kincaid Reading Ease and SMOG Index. In rest of the readability scores it is less than .05. So for the above two scores equal variances figures will hold true and vice versa in other cases. As significance value of t test is greater than .05 in all the cases, which depicts that there is no significant difference in readability scores calculated by all readability scores of annual reports of private sector banks. So the readability scores of annual reports of private sector banks are not influenced by their profitability levels. Hence the hypothesis for private sector is accepted and it can be concluded that readability calculated by all readability scores are not significantly different due to the profitability levels of the banks from both the sectors.

By the results of above figures, H01, H02, H03, H04, H05, and H06, is also accepted. Thus there is no significant difference of profitability on the readability Score of annual reports of banks.

The findings are supported by Courtis (1986); Subramanian, et al. (1993), they have examined the relationship between annual report readability and corporate profitability. Courtis (1986) finds neither company size nor profitability are associated with improved readability levels where as Baker and Kare (1992) find that the correlation coefficient between the readability index and the profitability of a firm is mixed. Subramanian et al. (1993), however, found a positive relationship between readability and profitability. Thus as per our findings banks with more profits or less profits do not show significant relationships with annual reports readability and understandability levels.

6. Limitations

The limitations of the study can be listed as:

6.1 The study only deals with banking sector. The study can range to various industries as per the requirement.

6.2 The parameter chosen for comparison is only profitability. There can be other measures to which may affect the readability scores of annual reports like age of the company, price to book value ratio.

6.3 The time period taken for study is of three years, which may be extended as per the need.

7. Conclusion

The research work undertaken talks about the comparison of readability levels of banks on the basis of profitability. This study demonstrates the research for banking sector. Almost all the banks of India are covered and so the sample of annual reports collected are 88. The study takes up the annual reports of banks for 3 years from 2009 to 2012. Furthermore 6 hypotheses are constructed to observe the relationship between the readability of annual reports and profitability levels of banks. Additionally, the findings do not hold up the obfuscation hypothesis, signifying that high (low) performing companies, in terms of profitability, had not achieved high (low) readability scores on company disclosures. The results imply that in the event of bad company performance management do not attempt to make company disclosure more prolix or syntactically complex in an effort to hide bad news. Therefore if the disclosures of the Company are more concise and syntactically simple then cannot be taken to indicate that the firm's performance was good. Also if we see the profitability values then higher or lower profitability levels do not make annual reports easier or harder to read and understand.

References

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Silky Janglani

Assistant Professor, Symbiosis University of Applied Sciences, Indore.

Simranjeet Kaur Sandhar

Assistant Professor, Symbiosis University of Applied Sciences, Indore. Table--I Descriptive Statistics for Readability Scores Readabilty Score Sector Variable N Flesch Kincaid Public Sector Banks Profitability >= .01 23 Reading Ease Profitability < .01 23 Private Sector Banks Profitability >= .01 21 Profitability < .01 21 Flesch Kincaid Public Sector Banks Profitability >= .01 23 Grade level Profitability< .01 23 Private Sector Banks Profitability>=.01 21 Profitability < .01 21 Gunning Fog Public Sector Banks Profitability >= .01 23 Index Profitability< .01 23 Private Sector Banks Profitability >= .01 21 Profitability< .01 21 SMOG Public Sector Banks Profitability >= .01 23 Index Profitability < .01 23 Private Sector Banks Profitability >= .01 21 Profitability < .01 21 Coleman Liau Public Sector Banks Profitability >= .01 23 Index Profitability< .01 23 Private Sector Banks Profitability >= .01 21 Profitability< .01 21 Automated Public Sector Banks Profitability >= .01 23 Readability Profitability< .01 23 Index Private Sector Banks Profitability >= .01 21 Profitability< .01 21 Readabilty Score Mean Std. Deviation Flesch Kincaid 42.17 4.92358 Reading Ease 41.293 5.37219 36.299 5.78664 38.416 3.76877 Flesch Kincaid 11.185 1.25743 Grade level 11.548 1.39224 12.897 1.57076 12.258 .96257 Gunning Fog 13.338 1.31799 Index 13.707 1.35582 14.982 1.64903 14.371 .97897 SMOG 13.34 1.03327 Index 13.64 1.02558 14.69 1.20444 14.21 .76675 Coleman Liau 12.095 .90898 Index 12.229 .85543 12.976 1.07411 12.701 .64153 Automated 10.144 1.63932 Readability 10.635 1.77812 Index 12.348 2.15642 11.518 1.28275 Table--II Independent Samples Test on Profitability and Readability Scores for Public Sector Banks Levene's t-test for Test for Equality Equality of Means of Variances F Sig. Flesch Equal .069 .795 Kincaid variances Reading assumed Ease Equal variances not assumed Flesch Equal .046 .832 Kincaid variances Grade assumed Level Equal variances not assumed Gunning Equal .180 .674 Fog variances Index assumed Equal variances not assumed SMOG Equal 1.03327 .21545 Index variances assumed Equal variances not assumed Coleman Equal .891 .350 Liau variances Index assumed Equal variances not assumed Automated Equal .159 .692 Readability variances Index assumed Equal variances not assumed 95% Confidence Interval of the Difference T Df Sig. (2- tailed) Flesch Equal .579 44 .566 Kincaid variances Reading assumed Ease Equal .579 43.6 .566 variances not assumed Flesch Equal -.929 44 .358 Kincaid variances Grade assumed Level Equal -.929 43.551 .358 variances not assumed Gunning Equal -.936 44 .354 Fog variances Index assumed Equal -.936 43.965 .354 variances not assumed SMOG Equal 1.03327 44 .330 Index variances assumed Equal 1.02558 43.998 .330 variances not assumed Coleman Equal -.515 44 .609 Liau variances Index assumed Equal -.515 43.839 .609 variances not assumed Automated Equal -.974 44 .335 Readability variances Index assumed Equal -.974 43.713 .335 variances not assumed 95% Confidence Interval of the Difference Mean Std. Lower Difference Error Difference Flesch Equal .8791 1.519 -2.1831 Kincaid variances Reading assumed Ease Equal .8791 1.519 -2.1838 variances not assumed Flesch Equal -.36348 .39118 -1.15185 Kincaid variances Grade assumed Level Equal -.36348 .39118 -1.15208 variances not assumed Gunning Equal -.36913 .39427 -1.16373 Fog variances Index assumed Equal -.36913 .39427 -1.16375 variances not assumed SMOG Equal -.29913 .30356 -.91092 Index variances assumed Equal -.29913 .30356 -.91092 variances not assumed Coleman Equal -.13391 .26027 -.65845 Liau variances Index assumed Equal -.13391 .26027 -.65850 variances not assumed Automated Equal -.49130 .50429 -1.50763 Readability variances Index assumed Equal -.49130 .50429 -1.50782 variances not assumed Upper Flesch Equal 3.9414 Kincaid variances Reading assumed Ease Equal 3.9420 variances not assumed Flesch Equal .42489 Kincaid variances Grade assumed Level Equal .42512 variances not assumed Gunning Equal .42547 Fog variances Index assumed Equal .42549 variances not assumed SMOG Equal .31266 Index variances assumed Equal .31266 variances not assumed Coleman Equal .39062 Liau variances Index assumed Equal .39068 variances not assumed Automated Equal .52503 Readability variances Index assumed Equal .52521 variances not assumed Table--III Independent Samples Test on Profitability and Readability Scores for Public Sector Banks Levene's t-test for Test for Equality Equality of Means of Variances F Sig. Flesch Equal 3.279 .078 Kincaid variances Reading assumed Ease Equal variances not assumed Flesch Equal 4.760 .035 Kincaid variances Grade assumed Level Equal variances not assumed Gunning Equal 4.223 .046 Fog variances Index assumed Equal variances not assumed SMOG Equal 3.226 .080 Index variances assumed Equal variances not assumed Coleman Equal 5.164 .029 Liau variances Index assumed Equal variances not assumed Automated Equal 7.455 .009 Readability variances Index assumed Equal variances not assumed 95% Confidence Interval of the Difference T Df Sig. (2- tailed) Flesch Equal -1.405 40 .168 Kincaid variances Reading assumed Ease Equal -1.405 34.380 .169 variances not assumed Flesch Equal 1.590 40 .120 Kincaid variances Grade assumed Level Equal 1.590 33.165 .121 variances not assumed Gunning Equal 1.461 40 .152 Fog variances Index assumed Equal 1.461 32.540 .154 variances not assumed SMOG Equal 1.541 40 .131 Index variances assumed Equal 1.541 33.924 .133 variances not assumed Coleman Equal 1.005 40 .321 Liau variances Index assumed Equal 1.005 32.658 .322 variances not assumed Automated Equal 1.517 40 .137 Readability variances Index assumed Equal 1.517 32.579 .139 variances not assumed 95% Confidence Interval of the Difference Mean Std. Lower Difference Error Difference Flesch Equal -2.11667 1.50695 -5.16232 Kincaid variances Reading assumed Ease Equal -2.11667 1.50695 -5.17791 variances not assumed Flesch Equal .63905 .40201 -.17344 Kincaid variances Grade assumed Level Equal .63905 .40201 -.17869 variances not assumed Gunning Equal .61143 .41848 -.23435 Fog variances Index assumed Equal .61143 .41848 -.24044 variances not assumed SMOG Equal .48000 .31157 -.14970 Index variances assumed Equal .48000 .31157 -.15324 variances not assumed Coleman Equal .27429 .27301 -.27749 Liau variances Index assumed Equal .27429 .27301 -.28138 variances not assumed Automated Equal .83048 .54753 -.27613 Readability variances Index assumed Equal .83048 .54753 -.28403 variances not assumed Upper Flesch Equal .92899 Kincaid variances Reading assumed Ease Equal .94458 variances not assumed Flesch Equal 1.45154 Kincaid variances Grade assumed Level Equal 1.45679 variances not assumed Gunning Equal 1.45721 Fog variances Index assumed Equal 1.46329 variances not assumed SMOG Equal 1.10970 Index variances assumed Equal 1.11324 variances not assumed Coleman Equal .82607 Liau variances Index assumed Equal .82996 variances not assumed Automated Equal 1.93708 Readability variances Index assumed Equal 1.94498 variances not assumed