Narrative disclosures in corporate annual reports: a syntactical complexity perspective

The Financial Reporting Council of the United Kingdom launched the Complexity project in 2008 to investigate the causes of complexity in annual reports, given increased concerns on the increasing size, complexity and the declining relevance of annual reports. However, to date, there is still limited academic evidence on the determinants and consequence of the complexity of annual reports, though annual reports remain increasingly complex. This thesis specifically investigates what determines the syntactical complexity of narratives in annual reports, and what is the consequence of syntactical complexity in annual report narratives. It does this by assessing in three empirical chapters (i) what firm characteristics determine the syntactical complexity in narratives, (ii) what board characteristics determine syntactical complexity in narratives, and (iii) what role do narratives play when investors react to earnings information. Syntactical complexity of narratives is measured using the fog index readability formula from computational linguistics, and the tone index measure, both widely used in assessing narratives in accounting research. The results reported in the first empirical chapter of the thesis indicate that specific characteristics of a firm determine the level of syntactical complexity of narratives. It shows that the performance of the firm, size of the firm, age of the firm, and the operations of the firm, play a role in the complexity of annual report narratives. The results reported in the second empirical chapter indicate that board composition factors determine the level of syntactical complexity of narratives. It shows that the age of directors, size of the board, percentage of female directors in the board, average board tenure and the number of nationalities in the board play a role in the level of complexity of annual report narratives. The third empirical chapter presents results indicating that the syntactical complexity of narratives increases with the Post Earnings Announcement Drift. It shows that the movement of post earnings return, in the direction of unexpected earnings, increases when management provide narratives with a more positive outlook. Overall, the results reported in this study indicate that the characteristics of the firm and the composition of the board of directors play a role in the level of complexity of annual report narratives. In addition, the results indicate that the syntactical complexity of annual report narratives, influences investors’ reaction to earnings information. These results are important for policy makers and regulatory bodies that are seeking to reduce the complexity and increase the relevance of annual reports. The results are consistent with the view that firm specific factors and the governance of the firm, are important in the narrative communication process, and that complexity of narrative communication affects resource allocation decisions.