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)

  • 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.

References

Garcia, Joy, Charl Villiers, and Lina (Zixuan) Li. 2020. “Is a Client’s Corporate Social Responsibility Performance a Source of Audit Complexity?” International Journal of Auditing 25 (1): 75–102. https://doi.org/10.1111/ijau.12207.
Gunning, Robert et al. 1952. “Technique of Clear Writing.”
Hoitash, Rani, and Udi Hoitash. 2017. “Measuring Accounting Reporting Complexity with XBRL.” The Accounting Review 93 (1): 259–87. https://doi.org/10.2308/accr-51762.
———. 2022. “A Measure of Firm Complexity: Data and Code.” Journal of Information Systems 36 (2): 161–72. https://doi.org/10.2308/isys-2021-041.
Hoitash, Rani, Udi Hoitash, and Ari Yezegel. 2021. “Can Sell-Side Analysts Experience, Expertise and Qualifications Help Mitigate the Adverse Effects of Accounting Reporting Complexity?” Review of Quantitative Finance and Accounting 57 (3): 859–97. https://doi.org/10.1007/s11156-021-00963-8.
Loughran, Tim, and Bill McDonald. 2020a. “Measuring Firm Complexity.” SSRN Electronic Journal. https://doi.org/10.2139/ssrn.3645372.
———. 2020b. “Textual Analysis in Finance.” Annual Review of Financial Economics 12 (1): 357–75. https://doi.org/10.1146/annurev-financial-012820-032249.