Effect of earnings quality on the financial reporting readability using the structural equation approach

Document Type : Original Article


Department of Accounting, Kerman Branch, Islamic Azad University, Kerman, Iran.


Companies' annual financial reports have been a major source of information for decision-making by capital market participants, market legislators, and other stakeholders. Also, the information contained in the financial statements which have high readability has a higher value. Managers use corporate disclosures to mislead or influence investors about corporate value. Earning quality is an important feature of the accounting system. The high quality of reported earnings through information transparency and market efficiency causes the highest accounting income and economic income alignment and indicates the usefulness of earning information for users in making decisions. Poor earning quality creates risk in resource allocation, slows economic growth through misallocation of capital, diverts resources to unprofitable projects, and increases information risk. The present study investigates the effect of earnings quality on the readability of financial reporting using the structural equation approach in companies listed on the Tehran Stock Exchange. The statistical population of the study is the companies listed on the Tehran Stock Exchange during the period 2006 to 2020 and the relationship is studied in 435 firm-years observation. Research findings indicate that earnings quality affects the readability of financial reporting.


  • Ahmadi, A., Ghaemi, M. (2019). Real Earnings Management and Financial Reporting Readability. Applied Research in Financial Reporting, 7(2), 45-72.
  • Ajina A., Danielle S., Lakhal F. (2016). Corporate Disclosures, Information Asymmetry and Stock-Market Liquidity in France. The Journal of Applied Business Research, 31, pp. 223-238.
  • Acock, A. C. (2013). Discovering structural equation modeling using Stata. Stata Press Books.
  • Ahrens, B. (2010). Capital market implications of earnings quality, 69. BoD–Books on Demand. ‏
  • Bagheri Azghandi, A, Hesarzadeh, R., and M. R., Abbaszadeh, (2018). Readability of financial statements, and investors' sensitivity to use of accounting information. Financial Management Perspectives, 23, pp. 87-103. In Persian.
  • Bhattacharya, U., Daouk, H. and Welker, M. (2003). The world price of earnings opacity, Accounting Review, 78 (3), pp. 641-678.
  • Biddle, G., Gilles, H., and Rodrigo, V. (2009). How does financial reporting quality relate to investment efficiency?
  • Bonsall, S.B. and Miller, B.P. (2017). The impact of narrative disclosure readability on bond ratings and the cost of debt, Review of Accounting Studies, 22 (2), pp. 608-643.
  • Bushman, R.M. and Smith, A.J. (2001). Financial accounting information and corporate governance, Journal of Accounting and Economics, 32 (2), pp. 237-333.
  • Bloomfield, R. (2008). Discussion of 'annual report readability, current earnings, and earnings persistence ", Journal of Accounting and Economics, 45 (2-3), pp. 248-252.
  • Bloomfield, R.J., (2002). "The Incomplete Revelation Hypothesis and financial reporting". Account. Horizons, 16, pp. 233–243.
  • Bonsall, S.B. and Miller, B.P. (2017), The impact of narrative disclosure readability on bond ratings and the cost of debt, Review of Accounting Studies, 22 (2), pp. 608-643.
  • Blanco, B., Coram, P., Dhole, S., & Kent, P. (2021). How do auditors respond to low annual report readability?. Journal of Accounting and Public Policy, 40(3), pp. 106-769.‏
  • Carmo, C.R., Moreira, J.A.C. and Miranda, M.C.S. (2016), Earnings quality and cost of debt: evidence from Portuguese private companies, Journal of Financial Reporting and Accounting, 14 (2), pp. 178-197.
  • Cohen, D. A. (2004). Quality of Financial Reporting Choice: Determinants and Economic Consequences: Doctor of Philosophy, Northwestern University.
  • Cornell, B. and Landsman, W. (2003). Accounting Valuation: Is Earnings Quality an Issue? Financial Analysts Journal, 59, pp. 20-29.
  • Courtis, J.K. (1986), An investigation into annual report readability and corporate risk-return relationships, Accounting and Business Research, 16 (64), pp. 285-294.
  • Drago, C., Ginesti, G., Pongelli, C., & Sciascia, S. (2018). Reporting strategies: What makes family firms beat around the bush? Family-related antecedents of annual report readability. Journal of family business strategy, 9(2), 142-150.‏
  • Dalwai, T., Chinnasamy, G. and Mohammadi, S.S. (2021), Annual report readability, agency costs, firm performance: an investigation of Oman's financial sector, Journal of Accounting in Emerging Economies, 11 (2), pp. 247-277. https://doi.org/10.1108/JAEE-06-2020-0142.
  • Ezat, A. N. (2020). The impact of earnings quality on the association between readability and cost of capital. Journal of Accounting in Emerging Economies. ‏
  • Hope, O., T. Kang, W. Thomas, Y.K. Yoo. (2008). Culture and auditor choice, A test of the secrecy hypothesis. Journal of Accounting and Public Policy, 27(5), 357-373. http,//dx.doi.org/10.1016/j.jaccpubpol.2008.07.00.
  • Inger, K. K., Meckfessel, M. D., Zhou, M., & Fan, W. (2018). An examination of the impact of tax avoidance on the readability of tax footnotes. The Journal of the American Taxation Association, 40(1), 1–29. doi:10.2308/ atax-51812.
  • Fama, E. and M. Jensen. (1983). Separation of ownership and control. Journal of Law and Economics, 26(2), pp.301-325.
  • Jabbarzadeh Kongerloui, S, Motavassel, M., and Y. Behnamoon, (2019). The Impact of Earnings Management and Financial Constraints on the Readability of Financial Reporting, Quarterly Journal of Stock Exchange, 46, pp. 5-25. In Persian.
  • Jensen, M. and Meckling, W. (1976). Theory of the firm: managerial behavior, agency costs and ownership structure", Journal of Financial Economics 3, 305–360.
  • Kumar, G. (2014). Determinants of readability of financial reports of U.S.-listed Asian companies. Asian Journal of Finance & Accounting, 6(2). doi:10.5296/ajfa.v6i2.5695.
  • LI, F. (2008). Annual Report Readability, Current Earnings, and Earnings Persistence. Journal of Accounting and Economics, 45, 221-247.
  • Lawrence, A. (2013). Individual investors and financial disclosure. Journal of Accounting and Economics, 56(1), 130–147. doi:10.1016/j.jacceco.2013.05.001.
  • Lehavy R, Li F, Merkley K, (2011). The effect of annual report readability on analyst following and the properties of their earnings forecasts. Account Rev 86:1087–1115.
  • Lo, K., Ramos, F. and Rogo, R. (2017), Earnings management and annual report readability", Journal of Accounting and Economics, 63, 1, pp. 1-25.
  • Miller, B. (2010). The effects of reporting complexity on small and large investor trading. The Accounting Review, 85(6), 2107–2143. doi:10.2308/accr.00000001.
  • Gibbons; D. Vickrey; D. Tierney; D. Brown. (2013). Sabrient/gradient earnings quality rank. White paper, 1 (1), 1-20.
  • Nowruzi, M, Azinfar, K, Abbasi, I., and I. Dadashi. (2020). Modeling and Evaluating the Modulating Role of Management Ability on the Relationship between Financial Reporting Readability and Agency Cost, Financial Accounting Research, 12 (1), pp. 1-18. In Persian.
  • Oud, J. H., & Delsing, M. J. (2010). Continuous-time modeling of panel data using SEM. In Longitudinal research with latent variables, pp. 201-244: Springer.
  • Parker, L. D. (1982). Corporate Annual Reporting: A mass communication perspective. Accounting and Business Research, 12(Autumn), 279–286. doi:10.1080/00014788.1982.9728820.
  • Pashalian, S., & Crissy, W. J. E. (1950). How readable are corporate annual reports? The Journal of Applied Psychology, 34(August), 244–248. doi:10.1037/h0061918 PMID:15436380.
  • Ramlall, I. (2016). Applied structural equation modeling for researchers and practitioners: Using R and Stata for behavioral research: Emerald Group Publishing.
  • Rezaei Pite Noei, Y., and M. Safari Graili (2018). Readability of Financial Reporting and the Possibility of Fraudulent Financial Reporting. Financial Accounting Research, No. 4 (38), pp. 43-58. In Persian.
  • Safari Graili M, Rezaei Pite Noei, Y., M., Nowruzi. (2017). Profit Management and Readability of Financial Reporting: An Empirical Test of Opportunistic Approach". Auditing knowledge. Pp. 217-230. In Persian.
  • Sukotjo, C., and Soenarno, Y. N. (2018). Tax Aggressiveness, Accounting Fraud, and Annual Report Readability. Journal of Finance and Economics, 6(2), 38-42.‏
  • Smith, J.E. and Smith, N.P. (1971). Readability: a measure of the performance of the communication function of financial reporting", The Accounting Review, 46, 3, pp. 552-561.
  • Soper, F. J., and Dolphin, R. (1964). Readability and corporate annual reports. The Accounting Review, (April), 358–362.