Do earnings management practices define the readability of the financial reports in India?

Abstract

Using a sample of the listed firms over the period 2007–2019, we examine the impact of financial statement readability on the earnings management in a large emerging economy, India. Besides, we test for the readability of financially distressed and financially constrained firms. We use the fog index to measure the readability of the Management Discussion and Analysis (MDA) section of the annual report, and earnings management is measured using the Jones model. Our results indicate that the firms practicing earning management activities prepare lesser readable financial reports. Our results remain the same after adding the firm‐fixed effect to control for firm‐specific characteristics. Thus, more financial manipulation practices by the firm make the financial reports more complex to comprehend.