Managerial Ability and Financial Reporting Readability: A Test of Signaling Theory

As an intangible asset, managerial ability is believed to be one of the components of corporate human capital. According to signaling theory, capable managers usually perform well and are less likely to hide their appropriate performance. Therefore, they tend to disclose more readable financial report, thereby communicating their optimum performance and ability to stakeholders and markets. According to this argument, thus, the present study is concerned with investigating the impact of managerial ability on the readability of corporate financial reporting. To this end, FOG Index and Text Length index are used to compute the readability of financial reporting, and to measure the managerial ability, Demerjian et al. (2012) model is employed. The research hypothesis was developed on a basis of a sample of 91 firms listed on the Tehran Stock Exchange during the years 2012- 2016, and then was tested using multivariate regression model based on panel data. Confirming the predictions made by signaling theory, the results suggest that managerial ability can improve corporate financial reporting readability. The results of additional analyses also reveal that the relationship between managerial ability and financial reporting readability is more pronounced in larger firms.