Does Annual Report Readability Affect Labor Investment Efficiency?

This study examines whether the complexity of textual narratives captured by annual report readability affects a firm’s labor investment efficiency. Using a large sample of US firms from 1994 to 2017, we find that linguistic simplicity through better annual report readability has a strong positive effect on a firm’s labor investment efficiency. Furthermore, we find that this positive association is more pronounced for firms suffering from weak monitoring. Our results are robust to additional control variables, endogeneity concerns, and alternative measures of annual report readability and labor investment efficiency. Using a difference-in-differences framework with the Plain Writing Act (PWA) 2010 as an exogenous variation in readability, we also document a causal relation between readability and labor investment efficiency. Overall, our core findings are consistent with the idea that readable annual reports positively affect firms’ financial flexibility, which, in turn, enhances the efficiency of firms’ labor investments.