Unverifiable net assets ratio and annual report reading difficulty

The Financial Accounting Standards Board (FASB) has greatly expanded the use of fair value instruments, which amplifies an increase of unverifiable assets and liabilities that do not have actively traded market prices. Prior research indicates that managers may have strong incentives to use discretion in estimating fair values of such assets and liabilities for his/her self-serving interests, leading to more agency conflicts. This study examines the impact of unverifiable net assets on reading difficulty of annual reports. We predict that annual reports of firms with more unverifiable assets and liabilities are more difficult to read because prior research links agency conflicts to increased reading difficulty. Our results show a significant positive relation between unverifiable net assets and reading difficulty, consistent with the agency theory. Our study has implications for revenue management because prior research links earnings management to annual report readability.