16.7 Firm Complexity
(Hoitash and Hoitash 2017) Accounting Reporting Complexity
Accounting complexity is defined as “the difficulty to understand, prepare, audit, and analyze the financial reports.” (p. 262)
Accounting reporting complexity (ARC) is based on the count of accounting items disclosed in eXtensible Business Reporting Language (XBRL) 10-K filings.
Operating complexity: measured by the number of business and geographic segments and the existence of foreign operations as measure of complexity
Linguistic complexity of financial reports (i.e., readability)
Fog Index (Gunning et al. 1952)
Length of 10-K filings
Data
XBRL from Calbench, criteria:
2011-2014 that filed within 150 days of the fiscal year-end
merge with compustat
positive sales, and non-missing common shares outstanding
assets > 10 mil
Exclude missing data on material weaknesses, audit fess, restatements from Audit Analytics
ARC is inversely associated with financial reporting quality
ARC is positively associated with audit delay and audit fees
(Hoitash and Hoitash 2022) Firm complexity
ARC was used to measure firm complexity
- It can be dis aggregated to measure the complexity of specific economic activities, (e.g., derivatives or leases)
Even though (Loughran and McDonald 2020a, 2020b) measure firm complexity using dictionary-based approach, the texts can sometimes refer to other companies’ activities, whereas accounting line items belong to the focal firm
Accounting disclosures comprise the majority of economic and corporate activity. Consequently, these disclosures can reflect company complexity holistically.
Other measures of complexity: such as number of operating segments (e.g., https://gist.github.com/joosti/213050de42d6e78f1634) using BUSSEG (business segments) and OPSEG (operating segment) in compustat.
(Hoitash, Hoitash, and Yezegel 2021) find that when complexity increases, analysts struggle to create accurate forecasts.
- (Garcia, Villiers, and Li 2020) find that CSR are positively correlated with greater ARC.