Predicting Bankruptcy with 10-K Length and Readability
Written communication contains intended and unintended messages, and computational advances are allowing practitioners and researchers to identify and extract these messages and the latent information embedded in how and what management says. This study considers the utility of two features of 10-K filings in the prediction of bankruptcy – readability and document length. The 10-K filing is a useful accounting artifact that is intended to address information asymmetry inherently present in the management/shareholder agency relationship. The creation of this document by management is a complex process that can impact management’s ongoing employment and compensation. Within this context, the management obfuscation hypothesis proposes that management will create more complex and less readable content in the presence of bad news in an effort to hide or minimize its impact. Using a common measure of readability (the FOG index) and document length this study demonstrates that these attributes are significant factors in the prediction of a firm’s filing for bankruptcy.
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