Annual report readability and investor sophistication

Abstract

This study examines the role of annual report readability on the behavior of capital market participants. Prior literature suggests that annual report readability contains additional information regarding firms’ performance and plays an important role on relieving information asymmetry. I find that bid-ask spreads, trading volumes, and analyst forecast dispersion are greater for firms with less readable 10-K reports. Also, I find that these effects are mitigated for firms with greater institutional holdings. In other words, low readability of 10-K reports, on average, prevents investors from readily interpreting the information contents of 10-K reports, but institutional investors are less affected by 10-K readability compared to the overall investors. My results are consistent with the disclosure quality literature, as 10-K readability can be a measure for disclosure quality. This study also contributes to the research of investor sophistication and the effect of annual report complexity on relieving information asymmetry.