EFFECT OF EARNINGS MANAGEMENT AND CASH HOLDINGS ON ANNUAL REPORT READABILITY: EVIDENCE FROM TOP INDIAN COMPANIES

This study explores the impact of earnings management (EM) on the readability of management discussion and analysis (MDA) section of annual reports of 384 Indian firms for 1,160 firm-years. We develop our hypothesis that the financial condition of firms can be interpreted from complexity of the financial disclosure. To investigate the link between readability and EM, we employ the modified Jones (1995) and Raman and Shahrur (2008) measures of discretionary accruals. As proxies of readability, we adopt multiple measures: FOG, Flesch-Kincaid, and SMOG. Further, the study explores the moderating role of cash holding in establishing linkage between readability and EM earnings. This study also captures whether the COVID-19 pandemic has actually impacted the readability of MDA report of Indian firms. Our findings suggest that: (1) Indian firms which meet or just beat the prior year earnings per share (EPS) and manage earnings, make MDA more complex; and (2) firms with less readable disclosures tend to increase their cash holding level significantly, especially as seen during the period of COVID-19 crisis. Our study contributes to the existing literature by exploring whether the ‘obfuscation hypothesis’ is applicable in the Indian context. Further, our study provides interesting insights for regulators and future research in emerging countries. To the best of our knowledge, as of now , no study has investigated the moderating behaviour of cash holdings in explaining readability of disclosure for firms that are involved in EM practice. The study accentuates the need for a suitable readability tool to assist sound decision making. Our findings also provide some insights for the regulators, financial intermediaries, and investors.

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