Journal of Accounting and Economics 60 (2015) 181186

Contents lists available at ScienceDirect

Journal of Accounting and Economics

journal homepage: www.elsevier.com/locate/jae

Discussion of Textual analysis and international nancial

reporting: Large sample evidence
Jason V. Chen a, Feng Li b,n,1
a
b

University of Illinois at Chicago, USA

Shanghai Advanced Institute of Finance, Shanghai Jiao Tong University, China

a r t i c l e i n f o

abstract

Available online 23 October 2015

Lang and Stice-Lawrence (2015) nd that rms which have adopted IFRS exhibit higher
quality textual characteristics in their annual reports. In addition, they nd that the textual characteristics of these annual reports are associated with rm economic outcomes.
In this discussion, we rst examine different explanations for each of these ndings. We
then examine the association between the length of U.S. 10-K lings and institutional
ownership in U.S. rms. In addition, we use a case study to illustrate the challenges in
establishing a causal relation between textual characteristics and economic outcomes.
Lastly, we provide suggestions for areas of future research.
& 2015 Published by Elsevier B.V.

Keywords:
Textual analysis
Annual report
International accounting
IFRS
Disclosure
JEL classication:
M41
F30
G15
K20

1. Introduction
In their study, Lang and Stice-Lawrence (2015) examine the relation between the textual characteristics of the annual
reports of over 15,000 non-U.S. rms and the economic outcomes for these rms. Specically, they focus on the relation
between a rm's adoption of IFRS and the length, readability, comparability, and boilerplate language contained within its
annual report. Their results show that rms that have adopted IFRS produce annual reports that are longer, more readable,
more comparable, and more likely to include report-specic language. In addition, they examine the relation between the
quality of the textual characteristics in a rm's annual report and its economic outcomes. Their analysis shows that rms
with annual reports of better textual quality exhibit greater liquidity, a higher percentage of institutional ownership, and
greater analyst following. Their study is among the rst to explore the textual characteristics of non-U.S. rms' annual
reports and to provide evidence that these characteristics are associated with economic outcomes. Overall, their paper
studies a new and interesting area in the eld of textual analysis, which has previously primarily focused on U.S. rms.
In this discussion, we begin by exploring different explanations for their nding of a relation between a rm's adoption of
IFRS and the textual characteristics of its annual report as well as their nding of a relation between textual quality and
economic outcomes. We then examine related evidence on the association between the length of U.S. rms' 10-K annual
lings and the percentage of institutional ownership for these rms. After providing a case study to illustrate the challenges

Corresponding author. Tel.: 86 21 6293 4533.

E-mail addresses: jchen19@uic.edu (J.V. Chen), i@saif.sjtu.edu.cn (F. Li).
1
We thank Jed Neilson and participants at the Journal of Accounting and Economics 2014 Conference for their helpful comments.

http://dx.doi.org/10.1016/j.jacceco.2015.10.003
0165-4101/& 2015 Published by Elsevier B.V.

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J.V. Chen, F. Li / Journal of Accounting and Economics 60 (2015) 181186

in establishing a causal relation between textual characteristics and economic outcomes, we conclude by providing suggestions for further work in this area.

2. Discussion
2.1. Adoption of IFRS and annual report textual characteristics
There are several possible explanations for Lang and Stice-Lawrence's nding of a change in the textual characteristics of
a rm's annual report after adopting IFRS. First, the adoption of IFRS often requires changes in rm accounting systems to
meet the new reporting standards (Barth et al., 2008). These changes may inherently lead to changes in the textual characteristics of the annual report since different accounting polices require different explanations from managers. Another
possible explanation is that IFRS has different disclosure requirements than does local GAAP. Meeting these new disclosure
requirements may entail both the disclosure of new information as well as changes in disclosure wording. For example, in
1998, the SEC made wording-specic recommendations for rm disclosures (U.S. SEC, 1998). A nal explanation for their
nding is that changes in the textual characteristics of annual reports may reect changes in a rm's underlying economics
around the adoption of IFRS (Downey, 2008).
These explanations have implications for how we interpret their nding of the relation between textual quality and
economic outcomes. That is, if textual characteristics change due to changes in disclosure requirements, then it is possible to
attribute the textual changes to changes in economic outcomes. However, if textual characteristics change due to changes in
the accounting system or the underlying economics of a rm, then the relation between textual characteristics and economic outcomes becomes less clear.
2.2. Causality
Establishing causality between the textual characteristics of an annual report and a rm's economic outcomes is a difcult task.
The authors acknowledge this challenge and choose an instrumental variables approach to establish a causal link. In particular, they
use the mandatory adoption of IFRS to instrument for the change in the textual characteristics of rms' annual reports, following
prior studies that have used this setting to examine the relation between IFRS and other rm characteristics (Byard et al., 2011;
Landsman et al., 2012). Using this approach yields a set of interesting yet puzzling results (see Table 8 of Lang and Stice-Lawrence).
While the directions for the coefcient estimates are similar to the directions for the respective coefcients in their cross-sectional
analysis (Table 6), the coefcient magnitudes are signicantly larger in the instrumented tests.
These larger coefcients could be caused by several different factors. First, it is possible that the textual characteristics of a rm's
annual reports are exogenous and therefore have better nite sample properties than the instrumented variables. However, this
explanation is unlikely due to the presence of potential uncontrolled, or uncontrollable, explanations for the textual characteristics.
Second, it is possible that heterogeneity in the treatment may affect the coefcient estimates since the instrument identies the
local average treatment effect for the subsample whose treatment status is manipulated by the instrument. This heterogeneity
could be due to differences in the use of English or in the voluntary adoption of IFRS. A third explanation for the larger magnitudes
of the estimated instrumental variables coefcients is that other changes occurring within a rm around the adoption of IFRS may
also affect economic outcomes. We discuss this explanation in further detail in the following section.
Lang and Stice-Lawrence provide a check for their use of mandatory IFRS adoption as an instrument by conducting an
additional analysis based on industry peer disclosures. This alternative instrument again yields coefcient estimates that are
directionally similar but of signicantly greater magnitude than the cross-sectional analysis estimates. This nding may
reect similar demands for transparency for peer rms and may thus omit managers' efforts to improve transparency
through other non-reporting channels (Daske et al., 2013).
2.3. Omitted variables
2.3.1. Accounting comparability and quality
Researchers have examined a number of possible effects of the adoption of IFRS on rms, their reporting environments,
and, ultimately, their economic outcomes. Namely, one channel through which IFRS is believed to affect economic outcomes
is through the improvement of accounting comparability (Barth et al., 2012). At the conceptual level, there has been substantial discussion about the effect of improved accounting comparability on nancial markets (De Franco et al., 2011). Lang
and Stice-Lawrence (2015) contribute to this discussion by suggesting that text comparability is one specic channel
through which comparability can affect economic outcomes.
While this suggestion is intriguing, empirically disentangling the effects of accounting number comparability and textual
comparability around the adoption of IFRS is challenging. In particular, there is likely to be overlap between the two
concepts since managers discuss the accounting process in the annual report and the accounting process is ultimately
reected in the accounting numbers.
Next, some suggest that the adoption of IFRS also leads to improvements in the quality of the accounting numbers
(Soderstrom and Sun, 2007). While accounting quality is dened in various ways, in general, improvements in accounting

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183

quality imply that the accounting information is more informative for investors. Indeed, Lang and Stice-Lawrence (2015)
nd that the quality of the textual disclosures is associated with more informed market participants. However, Barth et al.
(2008) nd that IFRS is also associated with improvements in the quality of the accounting numbers produced by management; that is, rms that adopt IFRS exhibit less earnings management, more timely loss recognition, and more value
relevance.
Lang and Stice-Lawrence are aware of the possibility that both accounting comparability and accounting quality
may be omitted variables in their primary analysis. In unreported results, they re-estimate their regressions after
controlling for discretionary accruals (Dechow and Dichev, 2002), discretionary smoothing (Lang et al., 2012), and
accounting comparability with both U.S. and non-U.S. rms (De Franco et al., 2011; Fang et al., 2013). These results are
unreported because they signicantly reduced the sample size and did not alter our conclusions. However, given the
importance of these omitted variables, future research may want to incorporate alternative samples or empirical measures
of accounting quality and comparability to ensure that the inferences made in Lang and Stice-Lawrence are not due to these
other factors.
2.3.2. Firm initiatives
Another set of factors that may impact their results are those related to rm initiatives. Specically, some suggest that
changes related to information technology, investor relations, and human resources took place around the adoption of IFRS
(Downey, 2008). Studies suggest that changes to these initiatives are likely to affect the economic outcomes of rms
(Bharadwaj, 2000; Healy et al., 1999). Moreover, these underlying economic changes likely impact the topics discussed by
management in the annual report.
2.3.3. English-language report sample
Lang and Stice-Lawrence focus their study on non-U.S. rms which provide annual reports in English. However, this
sample choice may reect a systematic correlation with economic outcomes. Jeanjean et al. (2010) nd that the choice of a
non-U.S. rm to provide its disclosures in English is related to both its governance and nancial concerns. Moreover,
managers who choose to report in English may be more likely to be situated in particular geographic locations (Brochet et
al., 2015). If so, then institutional differences across geographic locations such as the legal environment or enforcement
mechanisms may need to be accounted for when examining a rm's economic outcomes.
To mitigate this concern, Lang and Stice-Lawrence conduct an additional analysis in which they examine the relation
between the textual quality of annual reports and economic outcomes for non-U.S. rms which are English speaking. In
general, they nd that their results still hold for this subsample of rms. These additional ndings suggest it is less likely
that their results exist due to either an explicit choice by management to provide an annual report in English or differences
in management's use of English.
2.4. Use of annual reports
The analysis in Lang and Stice-Lawrence (2015) is based on the idea that changes in the textual characteristics of annual
reports due to the adoption of IFRS lead to greater transparency and more comparable reporting for rms. In turn, this
improvement in textual quality leads to more informed investors, which leads to changes in a rm's economic outcomes.
One assumption which underlies this argument is that market participants use the information contained in the annual
reports of non-U.S. rms' when making decisions. However, this assumption requires closer examination. Previous research
has found little evidence for a market reaction around the release of a U.S. company's annual report and related 10-K ling
(Cready and Mynatt, 1991; Li and Ramesh, 2009). These studies typically explain this result as a reection of the lack of new
information in a rm's annual report. If this is the case, one alternative interpretation of Lang and Stice-Lawrence's ndings
could be that annual report textual characteristics are similar to the textual characteristics of the rms' other disclosures, the
quality of which also changes upon IFRS adoption.

3. A simple analysis
Lang and Stice-Lawrence focus their study on a sample of English language reports from non-U.S. rms.
One potential criticism of their study is that their ndings may not be generalizable to other samples. In this section, we take
an initial step to examine the validity of this concern by examining the relation between the length of a U.S. rm's 10-K
annual reports and its percentage of institutional holdings. We also include a case study to help us illustrate the difculties
in their endeavor to establish a causal relation between the textual characteristics of a rm's disclosures and its economic
outcomes.
3.1. 10-K report length and institutional ownership for U.S. companies
We begin our simple analysis by examining whether a relation between the length of the 10-K ling and
the percentage of institutional holdings exists for U.S. companies. The data for this analysis is from scal

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Table 1
Shows the relation between the quintile rank of the number of words found in the 10-K and the percentage of institutional ownership for U.S. rms
between 1994 and 2014. Institutional ownership is estimated using 13-F lings. The number of words in the 10-K is measured as the number of words in
the entire 10-K ling, excluding tables. The number of words in the 10-K is ranked into quintiles by year. The number of words and the percentage of
institutional ownership in the rm are truncated at 1 and 99 percent of their respective distributions.
Quintile rank of 10-K length

Avg. institutional holdings

32.15%

41.20%

45.79%

49.14%

53.77%

Table 2
Presents the total number of words (minus tables) in the 10-K annual report, the Management Discussion and Analysis (MD&A) section of the 10-K, and the
Notes to the Financial Statements for Atrion Corporation between 2010 and 2012. Also shown is the percentage of institutional holdings for the company in
the respective years, estimated from their 13-F lings.
Fiscal year

10-K length
MD&A length
Notes length
Institutional holdings

Percentage change

2010

2011

2012

20102011

20112012

21,656
2,706
5,866
45.31%

25,405
2,946
5,670
47.85%

21,271
2,769
4,811
42.71%

17.31%
8.87%
 3.34%

 16.27%
 6.01%
 15.15%

years 1993 to 2014.2 The total number of rm year observations with all available data is 70,083. Institutional ownership for
each company is estimated using the rm's 13-F lings. The number of words in a rm's 10-K ling is measured using the
complete 10-K submission on EDGAR.
The ndings presented in Table 1 suggest that the length of a U.S. rm's 10-K is positively related to its percentage of
intuitional ownership. Specically, the results show that rm years which are in the lowest quintile of 10-K length on
average have institutional holdings of 32.15%. By contrast, the average percentage of institutional holdings increases to
41.20%, 45.79%, and 49.14% for rm years with 10-K lengths in quintiles 2, 3, and 4, respectively. The average percentage of
institutional ownership is the highest for rm years in the highest quintile of 10-K length, 53.77%.
Our ndings from our simple analysis are consistent with the ndings for non-U.S. rms in Lang and Stice-Lawrence. We
can use these ndings to suggest that lengthier textual disclosures lead to a more informative environment which in turn
leads to higher institutional investment in the company. While our simple analysis clearly has endogeneity issues, it does
help us to better understand the generalizability concerns raised with a study of non-U.S. rms.
3.2. Length and institutional ownership: a small case study
We next use a case study to highlight the potential concerns that arise with any attempt to establish a causal relation
between the textual characteristics of a rm's annual report and changes in its fundamental economic factors. In this case
study, we examine Atrion Corporation, a rm which experienced a notable increase and subsequent decrease in the length
of their 10-K ling over a three-year period.3
In addition to the overall length of the 10-K, we examine the lengths of two sections of the 10-K ling to gain a better
understanding of the relation between textual characteristics and report informativeness. Specically, we examine the
length of the MD&A section, which provides a discussion of the state of the rm by management, and the Notes to the
Financial Statements, which contains a discussion of the accounting policies used when deriving the nancial statements.
We see that the length of Atrion's 10-K increased sharply in 2011 and then decreased signicantly in 2012. This same pattern
(although not as drastic) occurred in its MD&A. The length of the Notes to the Financial Statements exhibited a general
downward trend with a notable decrease between 2011 and 2012.
By looking at the changes in 10-K length for Atrion, we can interpret the ndings as an indication that report length
reects informativeness. When the managers of Atrion provide more (less) information this leads to a more (less) salient
information environment, which drives an increase (decrease) in institutional investment in the company.
However, a deeper examination of Atrion's circumstances shows that part of the intertemporal variation in the length of
the lings can be linked to the termination of the company's dened benet retirement plan. In fact, the reduction in the
2

The SEC instituted a mandatory ling requirement through the EDGAR ling system around 1994 for all publicly traded companies within the U.S.
Atrion's 10-K lings for scal years 2010, 2011, and 2012 can be found on EDGAR at:
2010 http://www.sec.gov/Archives/edgar/data/701288/000115752311001534/0001157523-11-001534.txt.
2011 http://www.sec.gov/Archives/edgar/data/701288/000115752312001352/0001157523-12-001352.txt.
2012 http://www.sec.gov/Archives/edgar/data/701288/000115752313001345/0001157523-13-001345.txt.
3

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185

length of the Notes to the Financial Statements between 2011 and 2012 was largely due to the removal of the sections which
discussed the dened benet plan. While the change in disclosures related to the termination of the retirement plan certainly changed the textual characteristics of the company's lings, it seems unlikely that it would also be associated with a
change in institutional ownership via reductions in the information environment.
While this specic endogeneity concern may not apply directly to Lang and Stice-Lawrence, it does highlight the
endogeneity challenges regarding the relation between economic factors and disclosure textual characteristics. Moreover, it
demonstrates the need to identify instruments, as Lang and Stice-Lawrence do, in examining the relation between textual
characteristics and rm economic outcomes.

4. Future direction
Most studies in accounting and nance which examine the textual characteristics of rm disclosures have focused on the
disclosures provided by managers of U.S. rms (Li, 2008; Chen and Li, 2015). The work of Lang and Stice-Lawrence is one of a
handful of recent efforts to better understand the textual characteristics of non-U.S. disclosures and, perhaps more
importantly, the relation between textual characteristics and rm economic outcomes.
One potential interesting area for further research generated by their study is an examination of the thematic changes in
annual reports around the adoption of IFRS. Several recent studies have drawn on textual analysis techniques to examine the
thematic characteristics of disclosures (Huang et al., 2015). Understanding changes in the topics discussed following the
adoption of IFRS could shed light on the information-specic drivers of economic outcomes. Moreover, documenting differences between the disclosure practices outlined by IFRS and the actual disclosures by managers who adopt IFRS could
provide insight for regulators.
Future research based on their ndings might also examine the textual characteristics of other types of non-U.S. disclosures beyond annual reports. For example, conference calls and conference presentations are unique settings which have
been examined in the context of U.S. rms; however, little is known about their use by managers in non-U.S. rms (Frankel
et al., 1999; Bushee et al., 2011). The interactive nature of these disclosure channels could provide greater insight into how
managers in non-U.S. rms interact with the market.
Finally, another area of future research prompted by their study is an examination of whether a country's institutional
regime affects rm textual disclosures and, if so, what the implications are for market participants. Many studies suggest
that accounting standards alone do not dictate the nancial reporting environment (Ball et al., 2003; Holthausen, 2009).
Other forces such as manager and auditor incentives, regulation, and enforcement all likely play a role in shaping textual
disclosures and their use across countries. In sum, the work of Lang and Stice-Lawrence provides a number of interesting
conclusions as well as possible areas for future research.

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