Evaluaci´on de los algoritmos de escritura

Beside the literature about disclosure quality, there is another strand of research analyz- ing the complexity of disclosures. According to Hirshleifer and Teoh (2003), there is an inverse association between the volume of disclosures and the attention by the users of financial statements. Their results show that increasing complexity of the provided in- formation impairs the user`s understanding. The signal effect of individual parts of the notes can be reduced by more complex notes. As outlined in the previous section, the notes provide information about accounting policy choices and revenue recognition. This information is of crucial importance for the monitoring of earnings management. Therefore, the phenomenon of disclosure complexity impairs the detection of earnings management (Hirshleifer and Teoh, 2003).

This is in line with the study of Peterson (2012) who found out that more complex dis- closures increase the propensity to manage the earnings. His results show that an in- creasing level of complexity in the notes is beneficial for the implementation of earn- ings management. From the managers´ perspective, the complexity reduces the risk of scrutiny. Based on his findings, Peterson (2012) formulated the manipulation theory. According to this theory, managers opportunistically influence earnings when disclo- sures are more complex. This is due to the fact that disclosure complexity leads to de- creasing transparency of accounting information (Peterson, 2012). There are less oppor- tunities for the users of financial statements to monitor the behaviour of the manage- ment.

In correspondence with these findings, there are further studies that found evidence for the manipulation theory. The research of Hunton et al. (2006) examined this phenome-

64 non even before Peterson introduced the manipulation theory in the year 2012. Accord- ing to the results of Hunton et al. (2006), there is a higher degree of real earnings man- agement activities if the notes are complex. He focused on real cash flow elections by selling available-for-sale securities. The data sample of his experimental study included 61 US firms. In line with the manipulation theory, the findings of Hunton et al. (2006) show that managers tend to increase the volume of the notes if they aim to opportunisti- cally influence the earnings.

In the same vein, Huang and Zhang (2012) found out that there is a positive association between disclosure complexity and agency costs. Their survey research showed that more complex notes lead to decreasing usefulness of the provided information. The re- sults imply that the users of the financial statements find it difficult to recognize which information is significant in case of complex disclosures. In conclusion, Huang and Zhang (2012) state that more complex notes cause information asymmetries in the fi- nancial reporting. The principals have less information to monitor the behaviour of the agents. As a consequence, there is a higher probability for the management to influence the earnings without scrutiny.

In line with the findings of Huang and Zhang (2012), the study of Zeff (2007) implies that disclosure complexity leads to decreasing efficiency of monitoring regarding earn- ings management. According to Zeff (2007), complexity impairs the use of the notes as a monitoring mechanism. He concludes that complex notes are not appropriate in order to restrict the management from manipulating the earnings. Instead, his results show that alternative monitoring tools are required in case of disclosure complexity. As out- lined above, the notes to the accounts enable principals to evaluate the earnings quality at a cheaper cost compared to other monitoring tools. In result, Zeff (2007) states that the phenomenon of disclosure complexity leads to increasing principal-agency prob- lems. There can occur financial drawbacks through the requirement of costly monitor- ing methods.

In order to ensure the explanatory power of the notes, the content should be limited to meaningful and relevant information. According to Garrett et al. (2014), this kind of information is also known as material. They state that an item is qualified as material if it has the potential to change a decision of a shareholder or an investor. For instance, information that relates to future cash flows from an equity investment or loan is always material from an investor`s point of view.

65 Furthermore, the view of the US Supreme Court should be taken into account in order to assess which information is material. According to an important ruling of the US Su- preme Court, information is material if “[...] the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.” In contrast, the Court qualifies a fact as immaterial if investors regard that as purely ‘informative’, because “[...] management`s fear of ex- posing itself to substantial liability may cause it simply to bury the shareholders in an avalanche of trivial information - a result that is hardly conducive to informed decision making.” (TSC Industries, Inc. v. Northway, Inc., 426 U.S., p. 438, 429-450, 1976). In addition to the early but still valid definition of the term ‘materiality’ by the US Su- preme Court, it has to be taken into account that the total information provides a true and fair view of the firm`s financial situation (SEC, 2009). This means that not only the individual items have to be evaluated, but also the complete information disclosed by the notes. By following the SEC’s view (2009), the decision about meaningful and rele- vant information in the notes requires consideration of the firm`s industry and individu- al financial situation.

According to Hopwood et al. (2011), disclosure complexity is an important policy issue for the legislator and accounting standard setters. As described above, the financial notes can provide qualitative information regarding the firm`s current and future earn- ings. It is an important part of the financial reporting. The importance of this issue is also shown by the extensive literature in this field. There are several researchers who complain about the steadily increasing number of disclosures (e.g. Ryan, 2012; Peter- son, 2012; White, 2013). The high volume of disclosures leads to complexity and in- formation overload instead of more clearness (Ryan, 2012).

Moreover, disclosure complexity is a concern that occupies the SEC. The former chair of SEC stated that “when disclosure gets to be too much or strays from its core purpose, it could lead to what some have called information overload - a phenomenon in which ever-increasing amounts of disclosure make it difficult for an investor to wade through the volume of information she receives to ferret out the information that is most rele- vant.” (White, 2013, p. 27). According to the SEC (2009), the qualitative information in the notes improves the comparability of reported figures. The notes to the accounts ena- ble users of financial statements to assess the financial situation of the firm relative to

66 industry peers. Further, the earnings quality of different firms can be compared. How- ever, the degree of comparison is impaired in case of disclosure complexity.

In summary, it became aware that the notes to the accounts are a key part of the finan- cial reporting. They provide information about accounting policy choices and revenue recognition. This is of crucial importance to assess the earnings quality and detect earn- ings manipulations. Disclosure complexity leads to a decreasing effectiveness of this monitoring mechanism.

2.3.3 The Role of the Notes to the Accounts in Communication Theory