As well as selective use of graphs, annual reports might contain graphs that exhibit measurement distortion. Graphical guidelines suggest that the magnitude of change depicted in the graph should match that which is present in the underlying data [Steinbart, 1989; Beattie and Jones, 1992, 1997, 1999, 2000b; Frownfelter-Lohrke and Fulkerson, 2001; Hill and Milner, 2003]. When this is not the case, a graph is considered to exhibit measurement distortion, the extent of which is typically measured using the Graph Distortion Index (GDI) [Steinbart, 1989; Courtis 1997; Beattie and Jones 1999; Frownfelter-Lohrke and Fulkerson, 2001] The GDI is calculated as follows:
GDI = 100 * [(a/b) – 1]
Where: a is the percentage change depicted in the graph, measured as:
(height of last column – height of first column) (height of first column)
and b is the percentage change in the data.
An undistorted graph would have a GDI of zero because the term [(a/b) – 1] would equal zero as the percentage change in the graph (a) would be equal to the percentage change in the data (b). If the GDI is positive, the change shown on the graph is greater than that in the data so the trend is exaggerated. Conversely, a negative GDI indicates that a trend has been smoothed.
From an impression management perspective, where a preparer is attempting to emphasise positive performance, graphs showing favourable trends are likely to be exaggerated to make the situation appear even more positive that it is. However, a
negative trend, if shown at all, is more likely to be dampened to deemphasise its negativity. Exaggeration or overstatement of a trend can be achieved by use of a non-zero origin, and/or using a broken vertical scale or a non-arithmetic scale [Steinbart, 1989; Beattie and Jones, 1992, 1997; Hill and Milner, 2003]. Figure 5.2 provides an illustration of the effect of favourable measurement distortion. A
Figure 5.2 Favourable measurement distortion with a positive trend Part a: Undistorted graph
Sales 0 500 1000 1500 2000 2500 2003 2004 2005 2006 2007 $M
Part b: Graph with positive measurement distortion Sales 800 1000 1200 1400 1600 1800 2000 2003 2004 2005 2006 2007 $M
properly constructed graph with no measurement distortion is depicted in Part a. Part b contains positive distortion that has been achieved by using a non-zero origin, the effect of which is to overstate the apparent trend in the data.
A trend can be dampened or understated by using a non-proportional scale, where equal intervals do not equate to equal numerical amounts [Steinbart, 1989]. This latter effect is illustrated in Figure 5.3. Part a shows a declining sales trend with no distortion. Part b purports to show the same data but the graph has been improperly drawn with the proportionate change in the height of the columns being less than the corresponding change in the data. The desired impression is supported by the removal of values from the vertical axis and the absence of gridlines.
Research results indicate that measurement distortion is present in some annual report graphs and that the direction of distortion when it is present tends to be consistent with impression management motivations. For example, Steinbart [1989] found that 120 annual reports from his sample of 319 companies contained graphs with measurement distortion exceeding ten per cent, with the average distortion being just over eleven per cent. He examined those graphs displaying larger distortions more closely and found that fourteen annual reports in his sample contained graphs with a GDI of one hundred per cent or more. Of these, thirteen reports contained graphs that were distorted so as to exaggerate a favourable trend, a situation consistent with impression management behaviour.
Of the subsequent studies conducted which assessed graph distortion in annual reports, Beattie and Jones, [1992, 1997, 1999], Mather et al [1996], Courtis [1997] and Frownfelter-Lohrke and Fulkerson [2001] all report findings of significant distortion, the extent of which is documented in Table 5.1. In the majority of cases, distortion was favourable and exaggerated a positive trend [Beattie and Jones, 1992, 1997, 1999; Mather et al, 1996]. The most common cause of the distortion was that of improper scaling [Beattie and Jones, 1992, 1997; Courtis, 1997], resulting in a situation where “the graphic distance portrayed simply was not proportionate to the underlying data” [Beattie and Jones, 1997: 53]. Distortion resulting from the use of non-zero base lines and a broken vertical axis was also observed [Beattie and Jones, 1992, 1999; Frownfelter-Lohrke and Fulkerson, 2001].
Figure 5.3 Favourable measurement distortion with a negative trend Part a: Undistorted graph
Sales 5100 4700 4200 3600 3000 2003 2004 2006 2006 2007 $M
Part b: Graph with negative measurement distortion Sales 3000 3600 4200 4700 5100 2003 2004 2006 2006 2007 $M
In their international comparative study which included Australia, Beattie and Jones [2000b] report only limited evidence of measurement distortion but suggest that small sample sizes may have contributed to the lack of significant results. Godfrey et al [2003] failed to find significant measurement distortion in the annual report graphs of Australian companies which had changed their CEO. Nonetheless, as noted above, Mather at al [1996] and Beattie and Jones [1999] provide evidence that
measurement distortion is apparent in some Australian annual reports and its nature is suggestive of impression management.
Table 5.1 Research findings on the extent of graph distortion in annual reports Study Sample Key findings in regard to graph
distortion Beattie and Jones
1992
240 UK companies in 1989
30% of graphs had an absolute GDI of more than 5%
Mather et al 1996 Top 150 ASX listed companies in 1992
30% of graphs had an absolute GDI of more than 5%
Courtis 1997 691 Hong Kong companies in 1992/3 and 1993/4
52% of graphs had an absolute GDI of more than 5%
Beattie and Jones 1997
85 US companies and 91 UK companies in 1990-1
24% of reports from each country had graphs with an absolute GDI of more than 5%
Beattie and Jones 1997
89 ASX100 companies in 1997
32% of graphs had an absolute GDI of more than 5%
Frownfelter-Lohrke and Fulkerson 2001
37 US and 37 non-US companies
Average GDI for US graphs was 81%, average GDI for non-US graphs was 173%