The Impact of Corporate Governance Mechanisms on Readability of Audit Report

Abstract

Introduction Theoretically, due to the separation of ownership and management, audit and financial reports are regarded as a communication bridge between managers and outside stakeholders. Nevertheless, the increasing weakening of the readability levels of financial and audit reports in recent years has had an adverse effect on their communication performance. Therefore, the present study aims to examine the impact of corporate governance mechanisms on audit report readability in the Tehran Stock Exchange. 2- Hypothesis The present study uses six different corporate governance mechanisms including board independence, board financial expertise, board gender, CEO duality, audit committee independence and institutional ownership as potential mechanisms likely to affect audit report readability. Accordingly, we present our main and sub-hypotheses as follows: Main hypothesis: corporate governance mechanism affects audit report readability. Sub-H1: board’s independence affects audit report readability. Sub-H2: board’s financial expertise affects audit report readability. Sub-H3: board’s gender affects audit report readability. Sub-H4: CEO duality affects audit report readability. Sub-H5: audit committee independence affects audit report readability. Sub-H6: institutional ownership affects audit report readability. 3- Methodology We use Flesch and Fog readability indices as our readability measures. The statistical population of this research includes all listed companies on the Tehran Stock Exchange whose stocks are actively traded. A sample of 103 companies (721 firm-year observations) during the period 2011 to 2017 are chosen from this statistical population after lifting intended restrictions. 4- Results Our findings suggest that corporate governance mechanisms significantly affect audit report readability. More specifically, our findings indicate that corporate board’s independence, board’s financial expertise and CEO duality are significantly associated with audit report readability. 5- Conclusion The present research is among the applied researches. The audit report serves as a bridge between the auditor and the users of the financial statements, and therefore its transparency and legibility will give credibility and legitimacy to the auditors. In other words, the difficulty or illegibility of the audit report will reduce the desirability of the audit opinion. Therefore, it is expected that the findings of the present study could inform the Tehran Stock Exchange, auditing firms and auditing standard setters, including the Certified Public Accountants, to create and strengthen strategies to increase the readability of audit reports and more appropriate governance mechanisms and prevent managerial opportunistic behaviors such as earnings management in the future.