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Financial
Does audit quality moderate the statements
relationship between financial readability

statements readability and stock

price crash risk?
Bahaa Saleeb Agaiby Bakhiet Received 1 October 2023
Revised 30 November 2023
School of Accounting, Zhongnan University of Economics and Law, Wuhan, China 7 March 2024
and Accounting and Auditing Department, Faculty of Commerce, Accepted 26 March 2024

Assiut University, Assiut, Egypt

Abstract
Purpose – This study aims to examine the correlation between the readability of financial statements and
the likelihood of future stock price crashes in nonfinancial companies listed on the Egyptian Stock Exchange.
It further explores the possible moderating effect of audit quality on this relationship.
Design/methodology/approach – The study uses ordinary least squares regression, generalized least
squares estimation and two-stage least squares methodology to examine and validate the research hypotheses. The
sample comprises 107 nonfinancial companies registered on the Egyptian Stock Exchange from 2016 to 2019.
Findings – The results reveal a significant negative association between the readability of financial
statements and stock price crash risk. This suggests that companies with more complex financial statements
tend to experience higher future crash risks. Additionally, the study identifies audit quality as a significant
moderating factor. Higher audit quality, often indicated by engagements with Big-4 audit firms, strengthens
the influence of financial statements readability on stock price crash risk. This implies that while high audit
quality enhances investor confidence and market stability, it also accentuates the negative consequences of
complex financial statements.
Practical implications – The findings of this paper have significant implications for regulators and
standard-setting bodies in Egypt. They should consider refining and revising existing standards to
emphasize the importance of enhancing the readability of financial reports. Additionally, auditing firms
should actively engage in efforts to ensure clearer and more transparent financial reporting. These actions are
vital for boosting investor confidence, strengthening Egypt’s capital market and mitigating potential risks
associated with information opacity and complexity.
Originality/value – This study represents a pioneering endeavor within the Arab and Egyptian financial
environments. To the best of the author’s knowledge, it is the first examination of the association between the
readability of financial statements and stock price crash risk in these contexts. Furthermore, it explores
factors such as audit quality that may influence this connection.
Keywords Egypt, Emerging markets, Arabic, Audit quality(AQ), Financial statements readability (FSR),
Stock price crash risk (SPCR)
Paper type Research paper

The author extends sincere appreciation to Associate Professor Dr Tan Yanyan for her invaluable
guidance and unwavering support throughout this research. Additionally, gratitude is expressed to
the anonymous reviewers whose insightful feedback greatly contributed to the enhancement of this
Journal of Financial Reporting and
paper. Accounting
Conflict of interest: The author declares that there is no conflict of interest regarding the © Emerald Publishing Limited
1985-2517
publication of this paper. DOI 10.1108/JFRA-10-2023-0581
JFRA 1. Introduction
The issue of stock price crash risk (SPCR) has garnered considerable interest among investors,
corporations, regulatory bodies and academics, especially in the aftermath of prominent
company failures such as Enron, Parmalat, WorldCom and Xerox in the early 2000s, along
with the global financial crisis of 2008 which witnessed the collapse of numerous banks and
financial institutions. These events have profound implications for investor decision-making
and a company’s risk management practices (Murata and Hamori, 2021). Consequently, several
studies (Luo et al., 2021; Park and Song, 2018; Cho and Kim, 2020; Francis et al., 2016) have
focused on analyzing stock price behavior, volatility and other factors to identify the causes of
SPCR and its impact on international financial markets. Such occurrences lead to substantial
investor losses and erode confidence in the information included in companies’ financial
statements and reports. Therefore, there has been an increased emphasis on accounting
standards and financial statements, highlighting the pivotal role of high-quality, comparable,
readable and reliable financial information in maintaining the stability of financial markets and
aiding investors in making informed decisions.
Several accounting studies have identified multiple factors influencing the likelihood of
stock price crashes, such as accounting conservatism (Kim and Zhang, 2016), accounting
standards (DeFond et al., 2015) and environmental, social and governance disclosures
(Murata and Hamori, 2021). However, the primary driver of this risk is often attributed to
managerial behavior. Managers, as internal parties, tend to store, conceal or delay the
release of unfavorable information to investors and the financial community (Francis et al.,
2016). This behavior is driven by their desire to evade paying elevated corporation taxes
(Kim et al., 2011a), obtain increased equity compensation (Kim et al., 2011b), build their
empire and keep their career top position (Kim et al., 2016). However, managers’ ability to
store unfavorable news is limited. Over time, the accumulation of withheld information
reaches a threshold where it becomes unsustainable to continue hiding it. Eventually, the
accumulated unfavorable news is released all at once, resulting in a significant decrease in
the company’s stock price and generating SPCR (Liu and Lei, 2021).
There are various avenues through which managers can hide and conceal bad or unfavorable
news, such as earnings management (Li et al., 2022; Francis et al., 2016), opportunistic behavior
in tax determination (Kim et al., 2011a), conditional and unconditional conservatism (Kousenidis
et al., 2014; Kim and Zhang, 2016), financial statements comparability (Kim et al. 2014b; Parsa
and Sarraf, 2018), delayed issuance of financial reports (Li et al., 2020), complex and difficult to
read financial reports (Kim et al., 2019) and other avenues. In examining the complexity or low
readability of financial reports, previous studies (Arora and Chauhan, 2021; De Souza et al., 2019;
Lo et al., 2017; Boubaker et al., 2019; Bloomfield, 2008) propose two primary explanations. The
first is the ontological explanation, suggesting that conveying bad news inherently poses
communication challenges, leading to complex language. The second, the opportunistic
explanation rooted in the obfuscation hypothesis, posits that managers intentionally use
complex language to confuse investors, aiming to conceal poor performance or bad news and
manage users’ impressions and judgments about the company’s performance. These two
explanations shed light on the underlying factors contributing to complexity and potential
obfuscation in financial reports.
Consequently, the study problem revolves around examining the impact of financial
statements readability (FSR) on SPCR. In contrast to prior research that often concentrated
on the overall readability of annual reports (Saravanan et al., 2023), the board of directors’
report (Ezat, 2019) or auditor report readability (Dalwai et al., 2023a), this study specifically
explores the readability of annual financial statements and associated footnotes.
Additionally, it goes beyond exploring the direct association between FSR and SPCR by
examining how audit quality (AQ) moderates this relationship. Conducted in the Egyptian Financial
environment, where Arabic is the official reporting language, this study distinguishes itself statements
from similar prior research on FSR and SPCR. To the best of the author’s knowledge, this
readability
study stands as one of the few that explores the relationship between FSR and SPCR and is
the first of its kind in the Egyptian and Arab environments. Hence, the primary aim of this
study is to bridge the research gap by offering insights and addressing two key questions:

RQ1. Is there a relationship between the readability of financial statements and the
likelihood of a stock price crash in nonfinancial companies registered on the
Egyptian Stock Exchange?
RQ2. Does audit quality moderate the association between the readability of financial
statements and the likelihood of stock price crashes?
An essential motivation behind this study stems from the scarcity of empirical evidence
available on the association between FSR and SPCR, as well as the factors influencing this
relationship. This gap in the literature persists both globally and specifically within the
Egyptian and Arab environments. Therefore, investigating this relationship within the
Egyptian capital market, characterized as an emerging market with Arabic as the primary
reporting language, presents a valuable opportunity to address this research gap
comprehensively. By focusing on the Egyptian context, where linguistic and cultural
nuances may significantly impact the readability of financial statements, our study seeks to
provide insights that are not only relevant to the local market but also contribute to the
broader understanding of the relationship between FSR and SPCR in diverse socioeconomic
contexts. Through empirical investigation and analysis, we aim to enhance our
understanding of this relationship, thus providing stakeholders with valuable knowledge
for informed decision-making and policy formulation.
This study contributes significantly to the existing literature in several keyways. First,
focusing on Egyptian-listed companies fills a gap in research within this specific context
and provides valuable insights into market dynamics, regulatory environments and cultural
factors that may influence the relationship between FSR and SPCR. Additionally, this study
marks the first exploration of the association between FSR and SPCR in the Egyptian and
Arab environment, where Arabic is the official reporting language. Second, the study’s
significant findings have important implications for financial reporting practices in Egypt,
highlighting the importance of clear and readable reporting practices in reducing market
volatility and protecting investors’ interests. Regulators and standard-setting bodies can
leverage these insights to design or revise regulations aimed at promoting transparency in
financial reporting. Third, by incorporating AQ as a moderating variable, the study delves
into the potential impact of external assurance on the relationship between FSR and SPCR.
This contributes to understanding how AQ may either enhance or weaken the influence of
FSR on SPCR. Overall, this study advances the literature on FSR, SPCR and AQ, providing
valuable insights for both researchers and practitioners in the fields of accounting and
finance.
The subsequent sections of our paper are organized as follows: Section 2 offers a
background on the Egyptian context. The theoretical framework is presented in Section 3.
Section 4 includes the literature review and the development of the hypotheses. Section 5
defines the data and research methodology. The regression results are presented in Section
6. Sensitivity analysis and robustness tests are reported in Section 7, and finally, Section 8
contains the conclusion.
JFRA 2. Institutional background
Egypt stands as a prominent emerging economy within the Middle East and North Africa
region. Until the late 1980s, Egypt’s economic landscape adhered to a centrally planned
model. This period witnessed a limited role of the stock exchange and a notable deficiency in
the disclosure and utilization of financial information (Mostafa, 2016). However, starting in
the early 1990s, the Egyptian government began an economic liberalization journey,
implementing privatization initiatives and comprehensive economic reform programs. This
liberalization played a pivotal role in empowering local enterprises to secure more capital,
increasing investment prospects and attracting foreign direct investment, thereby
substantially bolstering economic progress (Ebaid, 2012). In response to these economic
transformations, the Egyptian Government enacted the Capital Market Law 95/1992,
placing the Capital Market Authority in charge of overseeing the registration and
mandatory disclosures for Egyptian firms (Diab et al., 2023). This legislative framework
mandated that listed companies, to maintain their registered status, must compile and
present three fundamental financial statements – including the income statement, the
statement of financial position and the statement of cash flow, accompanied by requisite
notes and disclosures – within three months of the fiscal year’s end (Diab et al., 2023; Ebaid,
2012).
In contrast to developed economies, Egypt is in the early stages of developing its investor
protection mechanisms, financial markets and corporate controls (Alm El-Din et al., 2022).
Despite these initial phases, Egypt has made significant strides in reforming its economy
and creating an investment-friendly environment to attract both regional and foreign
investors (Hussainey et al., 2011; Elsayed and Hoque, 2010). It is worth noting, however, that
the country’s progress is not immune to the influence of political events, such as the 2011
Arab Spring revolution, which had adverse effects on corporate accounting practices. This
impact is evident in the nonmonotonic nature of disclosure practices between 2011 and 2013,
which is attributed to the lack of supervisory and regulatory authorities during that period
(Aly et al., 2018). Consequently, this could influence the companies’ disclosure and its
readability (Alm El-Din et al., 2022).
According to Hassan et al. (2009), Egypt’s accounting measurements and disclosure
requirements are generally characterized by a greater degree of secrecy, conservatism and
lack of transparency. Therefore, a pressing need exists to improve financial reporting
credibility and corporate transparency. This is crucial for upholding trust in financial
markets and attracting investors. As a result, there has been a motivation to adopt and
implement international accounting standards (Mostafa, 2016). Nevertheless, emerging
economies like Egypt encounter a dearth of comprehensive nonfinancial and voluntary
disclosures due to inadequate regulatory mechanisms (Abdelsalam and Weetman, 2007;
Mohamed et al., 2019). In such market environments, investors heavily rely on the sole
readily available source of information: financial information, particularly companies’
earnings (Ebaid, 2012). However, given the developing state of the market, it is essential to
exercise caution when assessing corporate performance, especially when relying on
indicators like the quality of earnings and other accounting information. This caution stems
from the fact that managers, aiming to portray their companies favorably, may resort to
presenting difficult-to-read financial statements to obscure negative or adverse news.
The Egyptian Code of Corporate Governance (referred to as CG), introduced in 2005 and
updated in 2011, represents a hybrid of the US mandatory and the UK voluntary codes (Alm
El-Din et al., 2022). Despite its existence, the adoption of governance mechanisms outlined in
the code is still in its early stages in Egypt. Elsayed (2010) indicates an ineffective
application of CG rules, contributing to a deficiency in transparency and accountability
within Egyptian companies (Desoky and Mousa, 2012). This positions Egypt to embark on Financial
the second phase of enhancing CG procedures by adopting the CG code of 2016. The statements
emphasis is on reinforcing commitment and adherence to rules, enabling companies to
transparently elucidate the rationales behind instances of noncompliance (adopting a
readability
“comply or explain” approach). Moreover, there is a recognition of the significance of
incorporating internationally agreed-upon procedures as the optimal practices for firms
(Ebaid, 2016; AbdelFattah, 2018; Abdelhak et al., 2023).
In Egypt, companies have the discretion to issue annual reports, as no regulatory
requirement mandates firms to produce these reports. Instead, Egyptian firms must only
provide the Egyptian Stock Exchange with audited financial statements (Ezat, 2019).
Moreover, there is a notable absence of standardized formats for the contents of annual
reports among Egyptian companies. This lack of uniformity gives corporate managers
considerable flexibility concerning the information presented in these reports. As a result,
there may be considerable variations in disclosure practices and readability of annual
reports among Egyptian enterprises. (Alm El-Din et al., 2022).

3. Theoretical framework
The literature on the readability of financial statements explores various theoretical
perspectives to interpret FSR and understand managerial motivations behind disclosures.
These perspectives encompass several theories, including the obfuscation theory, agency
theory, signaling theory and legitimacy theory. The obfuscation theory or managerial
opacity, suggests that companies intentionally make their financial reports less readable
when performance is poor and more readable when performance is good (Li, 2008; Lo et al.,
2017; Bloomfield, 2008). Courtis (2004) defined obfuscation as a type of writing that conceals
or obscures the intended message. In this context, Bloomfield (2008) explained that company
management deliberately obscures bad news by writing difficult-to-read financial reports,
requiring investors and other stakeholders to invest more time, effort and skill to obtain the
appropriate information for decision-making. Therefore, the decreased readability of
financial reports contributes to increasing uncertainty about the true position of the
company. Moreover, complex financial reports consume significant time and effort from
external auditors during the audit process (Courtis, 2004; Bloomfield, 2008).
According to the agency theory, agency problems arise due to conflicts of interest
between principals (shareholders and stakeholders) and agents (managers) (Jensen and
Meckling, 1976). Managers may exploit the authority granted to them to maximize personal
benefits at the expense of shareholders and other stakeholders by concealing negative
information through less readable financial reports. This exacerbates information
asymmetry and agency problems (Dalwai et al., 2021; Luo et al., 2018). Therefore, the
increased information asymmetry between management and stakeholders resulting from
reduced readability can elevate SPCR when disclosing negative news to the market all at
once. Moreover, the decreased readability of financial reports requires auditors to gather
sufficient evidence to express their opinions on companies’ financial statements, leading to
additional effort and fees.
The signaling theory, developed by Spence (1973) and Ross (1977), is primarily used in
corporate financing decisions. Within the context of readability, this theory assumes that
companies with strong performance signal their strength by simplifying their financial
reports, making them more readable. Conversely, companies with poor performance often
attempt to conceal negative information from investors and other stakeholders for as long as
possible by increasing the complexity of their financial reports and making them less
readable (Abu Bakar and Ameer, 2010). Therefore, less readable financial reports serve as a
JFRA signal to investors, stakeholders and auditors, indicating the presence of risks surrounding
the company producing these reports. They also signal increased uncertainty associated
with the company’s future performance.
Regarding the legitimacy theory, built on the existence of a social contract between the
company and the community in which it operates, companies seek to legitimize their actions
by aligning with various societal perceptions, whether social, economic or environmental
(Gray et al., 1996; Hassan, 2008). In the context of readability, companies strive to achieve
legitimacy by simplifying their financial reports and making them more readable (Hassan
et al., 2019). Consequently, presenting complex financial reports may undermine a
company’s legitimacy in the eyes of investors, auditors and other stakeholders due to the
failure to meet their diverse perceptions.

4. Literature review and hypotheses development

4.1 Financial statements readability and stock price crash risk
Due to their access to extensive information regarding their companies’ performance,
profitability and business risks, company managers possess an informational advantage
over investors. They may exploit this advantage to conceal unfavorable performance or
news by preparing complex or less readable financial reports characterized by opacity,
thereby enabling personal gains and advantages (Kim et al., 2019).
Despite the multiple factors influencing SPCR, the primary reason for such collapses can
often be attributed to management’s withholding or concealment of negative news (Francis
et al., 2016). This behavior leads to increased opacity in financial reports, making it
challenging to detect managerial misconduct and consequently increasing the likelihood of
SPCR. A substantial body of prior research has provided empirical evidence supporting this
claim. For instance, Jin and Myers (2006) examined the effect of opacity and reduced
transparency in financial reports on crash risk. They found that companies that prepare
financial reports characterized by opacity are more prone to SPCR. Similarly, Chae et al.
(2020) discovered that the opacity of financial reports for Japanese companies positively
impacted crash risk. The same result was confirmed by Kim and Zhang (2014), who found
that opaque financial reporting enables management to conceal and accumulate negative
information for extended periods. Once the accumulated unfavorable information reaches a
specific threshold, it is suddenly and simultaneously disclosed to the market, leading to a
substantial drop in stock prices.
There are various ways through which top managers can hide negative news. One of
these strategies involves preparing complex and less readable financial reports, ultimately
resulting in an SPCR in the future. According to Kim et al. (2019), a decrease in the
readability of financial reports (as an indicator of complexity) positively influences SPCR.
These findings align with the proposition that managers can effectively conceal unfavorable
information through the utilization of intricate financial reporting. This subsequently
results in significant declines in stock prices when the concealed negative news accumulates
and ultimately reaches a critical threshold. In the context of the Egyptian and Arab business
environments, it is noteworthy that previous studies, conducted in Arabic, have explored
various determinants of SPCR beyond FSR. For instance, studies by Ibrahim (2016) and
Murad et al. (2021) have focused on the level of accounting conservatism, while Al-Sabbagh
(2019) examined the impact of accounting information quality. Additionally, Abdelrahim
(2022) centered on earnings management, and finally, Aita (2021) highlighted financial
reporting quality.
Reviewing relevant prior literature highlights a significant concern about SPCR due to its
importance to all stakeholders, both within and outside the company, as well as to the
overall financial markets. This concern is evident through the vast number of studies Financial
addressing the determinants and various factors for the occurrence of SPCR. Among these statements
factors, the financial reporting environment has emerged as a crucial element, with a focus
on managers’ withholding or concealment of negative news. Managers often resort to
readability
writing less readable and complex financial reports as a strategy to hide adverse
information for as long as possible, driven by specific motives and the pursuit of certain
advantages. The process of storing or withholding negative news may continue to
accumulate over time until it reaches a tipping point, at which management can no longer
store any bad news and disclosure becomes inevitable in one fell swoop to the market. This
inevitably leads to a sharp decline in the company’s stock prices, posing an SPCR.
While previous studies have explored various methods through which managers can
withhold negative news, there is a noticeable gap in the literature concerning the effect of
FSR on SPCR. As a key tool for concealing adverse information, FSR represents an essential
yet understudied aspect. When companies face financial challenges or possess negative
news that could harm their stock prices, the incentive to hide such information may lead to
selective disclosure or withholding of bad news through the preparation of complex or less
readable financial reports. Most existing studies have concentrated on different
determinants, leaving FSR relatively unexplored. Our paper aims to address this gap by
exploring the influence of FSR on SPCR, providing empirical evidence both globally and
specifically within the Arab and Egyptian contexts. In conclusion, our hypothesis posits
that writing less readable and complex financial reports allows managers to conceal
unfavorable information until it reaches a specific threshold. Upon reaching this threshold,
the release of accumulated negative news results in an SPCR. Consequently, we hypothesize
an inverse association between FSR and SPCR. Specifically, we anticipate that companies
presenting complex or difficult-to-read financial statements may encounter elevated future
SPCR. Therefore, our study’s initial hypothesis might be stated as follows:

H1. There is a negative relationship between financial statements readability and stock
price crash risk.

4.2 Financial statements readability, stock price crash risk and audit quality
External audits play a crucial role in enhancing users’ confidence in financial statements
and reducing information asymmetry (Coffie et al., 2018). Previous studies have identified
several indicators to measure AQ, including audit firm size, audit fees, auditor industry
specialization, audit tenure and experience (Xu et al., 2020; Karim and Sarkar, 2020; Devos
and Sarkar, 2015).
Multiple studies have examined the impact of AQ on the readability of financial reports,
revealing two potential directions for this relationship. The first direction suggests a
positive relationship between AQ and readability. Larger auditing firms, particularly the
Big-4, possess significant resources, capabilities and advanced technological tools that
enable them to produce more readable audit reports compared to smaller firms. These firms
use experienced technical writers and editors with expertise in crafting easily readable
reports (Smith, 2023). Auditors, especially those affiliated with Big-4 firms, play a crucial
role in instilling confidence in financial information by providing assurance that financial
statements and disclosures accurately represent the company’s true economic position.
Moreover, auditors from the Big-4 often use fewer footnotes, focusing only on the more
opaque information to prevent information overload and confusion. As a result, footnotes
reviewed by auditors from the Big-4 tend to be more easily readable than those from non-
Big-4 firms (Karim and Sarkar, 2020; Devos and Sarkar, 2015). Furthermore, Xu et al. (2020)
JFRA suggest that audit fees can influence the readability of financial reports. Higher audit fees,
indicative of increased audit hours, contribute to reduced earnings management, thus
mitigating management’s opportunistic behavior to make financial reports less readable.
Additionally, high-quality audit processes provide investors with more information,
reducing the potential for management obfuscation. Conversely, the second direction
proposes a negative relationship between AQ and readability. Larger auditing firms, by
their very nature, may have more complex internal controls and audit processes involving
multiple levels of review and intricate systems compared to smaller firms. Consequently,
complex issues may necessitate the use of intricate language, resulting in lengthy reports
with complex sentences and specialized technical terminologies (Chang and Stone, 2019a;
Chang and Stone, 2019b).
The significance of AQ extends to its impact on SPCR, as it serves as a tool to verify the
accuracy and credibility of financial reports – an essential information source for investors,
financial analysts and stakeholders (Habib et al., 2018). Robin and Zhang (2015) found a
negative correlation between external auditors’ industry expertise and SPCR for a sample of US
companies. Similarly, Khajavi and Zare (2016) explored the influence of AQ on SPCR, using
auditors’ industry expertise as an indicator of AQ, revealing a significant negative association
between AQ and SPCR. Lim et al. (2016) further examined the association between the
mandatory adoption of IFRS, AQ and SPCR. Their results indicated decreased risks of stock
price crashes for companies audited by one of the Big-4, attributed to error reduction, enhanced
transparency in financial reporting and an increased ability to detect negative news hiding or
withholding activities. Moreover, Callen and Fang (2017) investigated the association between
high AQ, measured by the length of the auditor-client relationship and future SPCR. Longer
relationships were found to enhance the auditor’s client-specific knowledge, increasing the
ability to detect and prevent bad news-hiding activities, consequently reducing future SPCR.
Furthermore, Yeung and Lento (2018) explored relationships between ownership structure,
board of directors structure, AQ and future SPCR. The findings indicated that a strong
ownership structure and a high degree of AQ decrease SPCR. Finally, Chae et al. (2020)
explained the influence of financial reporting opacity and AQ on SPCR, considering audit firm
size as an AQ indicator. The findings revealed that financial reporting opacity and lower AQ
increase the level of SPCR, considering AQ as a mitigating factor for these risks.
In summary, previous studies consistently suggest that high AQ reduces SPCR, acting as an
effective CG tool against managerial opportunistic actions and withholding bad news. This is
achieved through the reduction of information asymmetry, improved transparency in financial
reports and the verification of their credibility. Conversely, prior studies exploring the influence
of AQ on FSR have yielded mixed results, with some indicating a negative relationship and
others a positive one. However, none have examined the interactive effect of AQ on the
association between FSR and SPCR. Considering the potential impact of AQ on the relationship
between FSR and SPCR, the second hypothesis of our investigation is stated as follows:

H2. Audit quality moderates the relationship between financial statements readability
and stock price crash risk.

5. Data and methodology

5.1 Sample and data sources
Our study investigates the association between FSR and SPCR for Egyptian Stock
Exchange-listed nonfinancial companies, with AQ as a moderator. There are three major
reasons that make Egypt the prominent choice for conducting the empirical investigation.
First, Egypt is a significant and dynamic emerging market in the Arab world, housing a
diverse range of companies across various sectors. This diversity offers a multifaceted data Financial
set essential for exploring the intricate association between FSR and SPCR within an Arab statements
context. Second, Egypt’s official reporting language is Arabic, a distinguishing factor from readability
prior studies that predominantly focused on countries with English as the official language.
Third, Egypt’s financial regulatory landscape has recently undergone significant reforms
aimed at elevating financial reporting standards.
The study population encompasses all nonfinancial firms registered on the Egyptian Stock
Exchange from 2016 to 2019. This particular time frame was selected for a number of different
reasons. First, it follows Egypt’s adoption of IFRS in 2015. Second, financial reports for year “t”
are typically released after the accounting year ends, causing a lag in their impact on SPCR.
Thus, we examine the influence of FSR in a year “t” on SPCR in a year “t þ 1.” According to
Companies Law No. 159 of 1981, companies’ boards are required to submit audited annual
financial statements, along with an auditor’s report and a board of directors’ report. These
reports must be approved by the general assembly within 90 days of the fiscal year’s end.
Therefore, stock price data were systematically collected from the first week of April 2017 until
the last week of March 2021, assuming adherence to disclosure deadlines.
Consistent with prior studies (Seifzadeh et al., 2021; Ezat, 2019; Hassan et al., 2019; Luo et al.,
2018), this study did not include financial companies due to their distinct financial reporting
characteristics. This differs from the approach adopted by Dalwai et al. (2021) and Dalwai et al.
(2023b), who took a different strategy by concentrating on financial companies. Furthermore, the
sample selection process in this research involved specific criteria, including the availability of
annual financial statements, management reports and accessible share price data. Additionally,
firms with fiscal year-end dates different from December 31 were excluded to mitigate the
impact of specific events influencing share prices differently across companies. The study also
excluded nonfinancial companies that do not report their financial statements in the Egyptian
Pound to maintain consistency in the financial data. It is imperative to acknowledge that the
study commenced with a population of 693 observations, covering the complete study period.
Nevertheless, following the application of these criteria, 107 companies made up the final study
sample, yielding 428 observations overall. The data collection process for this study involves
using multiple sources, including reputable platforms such as MubasherInformation (www.
mubasher.info/countries/eg), the Egyptian Stock Exchange (www.egx.com.eg) and Investing
(https://sa.investing.com/), along with the official websites of the sampled companies.
Following the methodology outlined in Kim et al. (2019), we use ordinary least squares
(OLS) regression as the primary statistical method to investigate the relationship between FSR
and SPCR, with the moderating effect of AQ. To confirm the robustness of our results, we also
use the generalized least squares (GLS) estimation method. However, recognizing the potential
presence of endogeneity issues that could arise from omitted variables or reverse causality, we
adopt a two-stage least squares (2SLS) approach as a complementary method.

5.2 Variables selection and measurement

5.2.1 Dependent variable: stock price crash risk. We use two well-established indicators,
down-to-up volatility (DUVOL) and negative conditional return skewness (NCSKEW), to
measure SPCR. These measures have been widely used in prior research to assess SPCR for
each firm year (Kim et al., 2011b; Hutton et al., 2009; Chen et al., 2001; Li et al., 2022; Kim and
Zhang, 2016; Kim et al., 2011a; Yeung and Lento, 2018; Francis et al., 2016; Li et al., 2020).
These measures are calculated by initially using the subsequent regression equation within
the expanded market model to derive residuals:
JFRA ri;t ¼ ai þ b1;i rm;t2 þ b2;i rm;t1 þ b3;i rm;t þ b4;i rm;tþ1 þ b5;i rm;tþ2 þ «i;t (1)

where ri,t is the stock return of firm i at week t, rm,t is the market return at week t and two
weeks forward and backward the current week for the weekly market return, allowing for
nonsynchronous trading of stocks (Kim and Zhang, 2014) and «i,t is the residual return. Next,
the firm-specific weekly return for firm i and week t, denoted as Wi,t, is computed by taking the
natural logarithm of one plus the residual return estimated in equation (1) as follows:


Wi;t ¼ Ln 1 þ «i;t (2)

DUVOL divides a company’s weekly returns over a specific period into two groups: down
weeks (observations below the annual mean) and up weeks (observations above the mean).
Separate standard deviations are calculated for each group, and DUVOL is determined by
taking the natural logarithm of the ratio between the standard deviation of weekly stock
returns during down weeks and up weeks. The following equation represents this measure:
X
ðNu  1Þ W2
DUVOLi;t ¼ Ln Xdown i;t
ðNd  1Þ W2
up i;t

NCSKEW is calculated as the negative value of the third moment of firm-specific weekly
returns divided by the standard deviation of firm-specific weekly returns raised to the third
power. This measure is calculated as follows:
3X
nðn  1Þ2 W3
NCSKEWi;t ¼  X i;t 
3=2
ðn  1Þðn  2Þ Wi;t2

A higher NCSKEW and DUVOL values suggest an increased vulnerability of the firm to
stock price crashes (Habib et al., 2018).
5.2.2 Independent variable: financial statements readability. This study uses the
information overload approach to measure FSR, incorporating indicators that consider both
the amount of information contained in financial reports and the length of these reports (Luo
et al., 2018; Loughran and McDonald, 2014; Li, 2008). This methodology is especially well-
suited for the Egyptian setting, in which Arabic serves as the predominant language for
financial reporting. It is recognized for its simplicity, resistance to measurement errors and
ease of replication. On top of that, its applicability to financial reports written in any
language, including English and others, confers an advantage over linguistic textual
analysis. Under this approach, we adopt two distinct methods, each providing valuable
insights into the reduced readability and complexity of financial reports.
Consistent with Luo et al. (2018) and Dalwai et al. (2021, 2023b), the first method involves
taking the natural log of the total number of pages in the company’s annual financial
statements and accompanying footnotes, denoted as (READ_Pages). This method considers
larger financial statements with a greater number of pages as indicative of reduced
readability or heightened complexity, and it can be represented by the formula:

READ_Pages ¼ Ln ðTotal Number of PagesÞ

 Additionally, congruous with Cheung and Lau (2016) and Abernathy et al. (2019), the second Financial
method uses the natural log of the number of footnotes attached to the annual financial statements
statements, denoted as (READ_Footnotes). A higher number of footnotes suggests larger
financial statements and, consequently, reduced readability. The formula for this method is:
readability

READ_Footnotes ¼ Ln ð Number of FootnotesÞ

Both measurements serve as reverse measures of readability, enabling us to explore the

potential impact of larger and more extensive financial statements on SPCR.
5.2.3 Moderating variable: audit quality. Prior research has typically categorized AQ as
either high or low based on associations with the Big-4 accounting firms. These firms are
often regarded as proxies for superior AQ due to their extensive internal training programs,
rigorous peer reviews and consistent efforts to uphold their professional reputation (Becker
et al., 1998; Krishnan, 2003). Becker et al. (1998) noted that large auditing firms, particularly
the Big-4, are more adept at minimizing managerial manipulations of earnings compared to
smaller firms. Moreover, Jensen and Meckling (1976) observed that larger accounting firms
demonstrate higher independence, stemming from reduced economic reliance on the audited
firm, thereby substantially decreasing the likelihood of misconduct by the audited firm.
In line with these considerations, we operationalize AQ using audit firm size, assigning a
value of 1 if the audit office is either one of the Big-4 or affiliated with it and 0 otherwise
(Chae et al., 2020; Lim et al., 2016; Yeung and Lento, 2018). This approach allows us to
capture the potential influence of superior AQ, as represented by affiliation with the Big-4,
on the relationship between FSR and SPCR.
5.2.4 Control variables. Our study incorporates an extensive array of control variables to
comprehensively understand the factors influencing SPCR, aligning with established practices
in previous studies (Wattanatorn and Padungsaksawasdi, 2022; Dang et al., 2018; Chang et al.,
2017; Kim et al., 2014a, 2014b; Thai et al., 2023; Kim et al., 2019; Lim et al., 2016; Yeung and
Lento, 2018; Callen and Fang, 2017). These variables are SIZE, ROA, LEV, SIGMA, RET, BS,
B_INDEP and BMF. Table 1 shows the variables’ description and measurement.

5.3 Models specification

5.3.1 Baseline model. The main model, used to test the first hypothesis and examine the
relationship between FSR and SPCR, is depicted as follows:


SPCRi;tþ1 NCSKEWi;tþ1 or DUVOLi;tþ1 ¼ b0 þ b1 READ_Pagesi;t þ b2 SIZEi;t þ b3 LEVi;t

þ b4 ROAi;t þ b5 RETi;t þ b6 SIGMAi;t þ b7 BSi;t

þ b8 B_INDEPi;t þ b9 BMFi;t þ «i;t

5.3.2 Moderating effect model. To investigate the moderating role of AQ, the following
model is used:


SPCRi;tþ1 NCSKEWi;tþ1 or DUVOLi;tþ1 ¼ b0 þ b1 READ_Pagesi;t þ b2 AUDITi;t


þ b3 READ_Pagesi;t  AUDITi;t þ b4 SIZEi;t

þ b5 LEVi;t þ b6 ROAi;t þ b7 RETi;t þ b8 SIGMAi;t

þ b9 BSi;t þ b10 B_INDEPi;t þ b11 BMFi;t þ «i;t

5.3.3 Alternative variable measurement model. As part of sensitivity analysis, we consider

alternative measurements for the independent variable, FSR. Instead of using the natural log
JFRA Variables Acronym Measurement

Stock price crash DUVOL The natural logarithm of the ratio between the standard
risk deviation of firm-specific weekly returns during the down
weeks and the standard deviation during the up weeks
NCSKEW The negative value of the third moment of firm-specific weekly
returns for each sample year is divided by the standard
deviation of firm-specific weekly returns raised to the third
power
Financial statements READ_Pages The natural logarithm of the total number of pages comprising
readability the company’s annual financial statements and footnotes
READ_Footnotes The natural logarithm of the number of footnotes attached to
the annual financial statements
Audit quality AUDIT Takes (1) if the audit office is one of the Big-4 or affiliated, (0)
otherwise
Firm size SIZE The natural logarithm of total assets
Financial leverage LEV The proportion of total liabilities to total assets
Return on Assets ROA Net income divided by total assets
Return volatility SIGMA The standard deviation of firm-specific weekly returns
Average weekly RET The mean of firm-specific weekly returns over the fiscal year,
returns times 100
Board size BS The number of members of the board of directors
Board independence B_INDEP The ratio of nonexecutive directors to the total number of board
members
Board meetings BMF The total number of board meetings conducted by a company
Table 1. frequency each year
Variables description
and measurement Source: Author’s own creation

of the number of pages, we redefine FSR as the natural log of the number of footnotes.
Consequently, the baseline model will be retested under this revised measurement method
using the model:


SPCRi;tþ1 NCSKEWi;tþ1 or DUVOLi;tþ1 ¼ b0 þ b1 READ_Footnotesi;t þ b2 SIZEi;t þ b3 LEVi;t

þ b4 ROAi;t þ b5 RETi;t þ b6 SIGMAi;t þ b7 BSi;t

þ b8 B_INDEPi;t þ b9 BMFi;t þ «i;t

5.3.4 Addressing endogeneity problem models. To mitigate potential endogeneity concerns

in our analysis, we propose using instrumental variables (IV) in conjunction with the 2SLS
method. In this study, we use the average level of industry FSR as an IV to address
endogeneity concerns. The initial stage of the 2SLS regression involves estimating the
relationship between the endogenous variable (FSR) and the IV (average industry-level FSR)
to derive the predicted or fitted values of the endogenous variable. The IV, “Ave_Pages,”
represents the average level of FSR within the industry. The first stage model is as follows:

READ_Pagesi;t ¼ b0 þ b1 Ave_Pagesi;t þ b2 SIZEi;t þ b3 LEVi;t þ b4 ROAi;t þ b5 RETi;t

þ b6 SIGMAi;t þ b7 BSi;t þ b8 B_INDEPi;t þ b9 BMFi;t þ «i;t

After obtaining the predicted values of FSR in the first stage, we move on to the second Financial
stage of the 2SLS regression. In this stage, we use the predicted values of READ_Pages statements
(denoted as READ_Pages_hat) as a proxy for the endogenous variable to estimate the
association between FSR and SPCR. The second stage model is as follows:
readability

NCSKEWi;tþ1 ¼ b0 þ b1 READ_Pages_hati;t þ b2 SIZEi;t þ b3 LEVi;t þ b4 ROAi;t

þ b5 RETi;t þ b6 SIGMAi;t þ b7 BSi;t þ b8 B_INDEPi;t þ b9 BMFi;t þ «i;t

6. Empirical analysis
6.1 Descriptive statistics
The descriptive statistics presented in Table 2 offer a comprehensive overview of the main
variables under examination. Looking at the indicators for one-year-ahead SPCR, the mean
values for NCSKEWtþ1 and DUVOLtþ1 are 0.214 and 0.148, respectively. Moving to
FSR, the mean values for READ_Pages and READ_Footnotes are 3.476 and 3.377,
respectively. AQ, represented by the variable AUDIT, exhibits an average value of 0.395.
The interaction variable between FSR and AQ is further explored, revealing a mean value of
1.584. Examining firm characteristics, the mean firm size is 20.499. Additionally, the table
provides insights into other financial metrics, including an average ROA of 0.037, a mean
LEV of 0.385, a mean SIGMA of 0.052 and an average RET of 0.139. Transitioning to
board-related variables, the mean board size is 8.061 members, with an average of 69% of
board members being independent. Furthermore, the mean frequency of board meetings
within the sample is 7.836.

6.2 Correlation analysis

The correlation matrix presented in Table 3 depicts the pairwise relationships between the
two measures of SPCR, namely, NCSKEWtþ1 and DUVOLtþ1, and a set of other variables in
the study. In general, the coefficients exhibit a moderate or low level, demonstrating the
absence of multiple collinearities among the independent variables. The outcomes show a
strong positive and significant relationship between NCSKEWtþ1 and DUVOLtþ1,
indicating that both are reliable indicators of SPCR and can be used interchangeably in
subsequent analyses. Additionally, both SPCR measures exhibit a significant positive
correlation with the number of pages and footnotes in financial statements. Given that
READ_Pages and READ_Footnotes serve as reverse indicators of FSR, these positive
correlations imply that companies with complex financial statements are prone to
encountering an increased crash risk. Interestingly, the interaction variable READ_Pages 
AUDIT, capturing the joint influence of FSR and AQ, reveals a moderate positive correlation
with NCSKEWtþ1 and DUVOLtþ1. These results suggest that the association between FSR
and SPCR is intricately linked to AQ.
Considering control variables, significant positive associations between SPCR proxies
and SIZE suggest that larger firms tend to have higher subsequent crash risk. LEV also
shows a significant positive correlation with SPCR, implying that firms relying more on
debt financing are associated with elevated crash risk. The results also reveal significant
positive correlations between SIGMA and SPCR measures, suggesting that higher stock
return volatility is linked to increased crash risk, reflecting greater market uncertainty and
risk, leading to more pronounced price swings and crash events. Additionally, significant
positive correlations between RET and SPCR measures indicate that as weekly returns rise,
the likelihood of stock price crashes increases. This association may be attributed to factors
JFRA Variables N Mean SD Minimum Maximum

NCSKEWtþ1 428 0.214 0.677 1.922 1.972

DUVOLtþ1 428 0.148 0.394 1.223 1.43
READ_Pages 428 3.476 0.325 2.639 4.407
READ_Footnotes 428 3.377 0.257 2.639 4.205
AUDIT 428 0.395 0.489 0 1
READ_Pages  AUDIT 428 1.584 1.843 0 4.407
SIZE 428 20.499 1.811 16.937 24.902
ROA 428 0.037 0.098 0.943 0.341
LEV 428 0.385 0.206 0.001 0.94
SIGMA 428 0.052 0.038 0.01 0.319
RET 428 0.139 0.133 0.999 0.033
BS 428 8.061 2.767 3 17
B_INDEP 428 0.69 0.199 0 1
BMF 428 7.836 3.638 2 25

Notes: NCSKEWtþ1 ¼ negative conditional return skewness; DUVOLtþ1 ¼ down-to-up volatility;

READ_Pages ¼ natural logarithm of the number of pages; READ_Footnotes ¼ natural logarithm of the
number of footnotes; AUDIT ¼ audit quality; READ_Pages  AUDIT ¼ the interaction variable between
financial statements readability and audit quality; SIZE ¼ firm size; ROA ¼ return on assets; LEV ¼ financial
leverage; SIGMA ¼ return volatility; RET ¼ average weekly returns; BS ¼ board size; B_INDEP ¼ board
Table 2. independence; BMF ¼ board meetings frequency. A detailed description of variables is provided in Table 1
Descriptive statistics Source: Author’s own creation based on the statistical analysis

such as increased market volatility, higher speculative activities or higher sensitivity to

market shocks, contributing to larger price swings and an elevated SPCR. Finally, the
findings reveal noteworthy correlations between board-related variables and SPCR. The
significant negative correlations of BS, B_INDEP and BMF with SPCR measures suggest
that companies with larger boards, a greater percentage of independent directors, and more
frequent board meetings tend to have lower SPCR. These findings imply that effective
governance mechanisms may contribute to the mitigation of severe price declines.

6.3 Regression results

6.3.1 Baseline regression results. The baseline regression analysis, presented in Table 4,
investigates the influence of FSR, measured by the natural log of the number of pages
(READ_Pages) as a reverse measure, on one-year-ahead SPCR, measured by NCSKEWtþ1
and DUVOLtþ1. Models 1 and 2 focus on the association between READ_Pages and
NCSKEWtþ1, while Models 3 and 4 use DUVOLtþ1 as a proxy for SPCR.
In Model 1, a simple regression analysis without any control variables was performed.
The result reveals a significant positive association (coefficient ¼ 0.545, t-values ¼ 5.4, p <
0.01), suggesting that companies with less readable or complex financial statements are
associated with higher subsequent SPCR. This result remains consistent in Model 2, where
relevant control variables are introduced, and the significant positive relationship persists
(coefficient ¼ 0.531, t-values ¼ 4.43, p < 0.01). Thus, these findings confirm the existence of
a significant negative relationship between FSR and SPCR. Moving on to the next models,
Models 3 and 4 use DUVOLtþ1 as a proxy for SPCR. Both models consistently show a
significant positive association between READ_Pages and DUVOLtþ1, indicating that a
higher number of pages in financial statements leads to lower readability and
increases eventual SPCR. The results of the four models are consistent with the findings of
Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)

(1) NCSKEWtþ1 1.000

(2) DUVOLtþ1 0.938*** 1.000
(3) READ_Pages 0.280*** 0.283*** 1.000
(4) READ_Footnotes 0.268*** 0.265*** 0.784*** 1.000
(5) AUDIT 0.162*** 0.173*** 0.581*** 0.404*** 1.000
(6) READ_Pages  AUDIT 0.251*** 0.257*** 0.658*** 0.495*** 0.532*** 1.000
(7) SIZE 0.178*** 0.172*** 0.636*** 0.577*** 0.551*** 0.576*** 1.000
(8) ROA 0.011 0.034 0.018 0.004 0.004 0.006 0.080* 1.000
(9) LEV 0.171*** 0.171*** 0.345*** 0.353*** 0.259*** 0.281*** 0.387*** 0.086* 1.000
(10) SIGMA 0.111** 0.113** 0.025 0.033 0.019 0.009 0.064 0.061 0.103** 1.000
(11) RET 0.156*** 0.164*** 0.200*** 0.183*** 0.166*** 0.187*** 0.255*** 0.065 0.008 0.424*** 1.000
(12) BS 0.294*** 0.260*** 0.167*** 0.162*** 0.051 0.042 0.192*** 0.033 0.028 0.028 0.029 1.000
(13) B_INDEP 0.142*** 0.137*** 0.054 0.142*** 0.009 0.002 0.058 0.008 0.006 0.033 0.016 0.333*** 1.000
(14) BMF 0.089* 0.093* 0.199*** 0.159*** 0.174*** 0.160*** 0.194*** 0.137*** 0.116** 0.056 0.052 0.065 0.112** 1.000

Notes: ***, ** and * represent statistical significance at the 1, 5 and 10% levels, respectively; NCSKEWtþ1 ¼ negative conditional return skewness; DUVOLtþ1 ¼
down-to-up volatility; READ_Pages ¼ natural logarithm of the number of pages; READ_Footnotes ¼ natural logarithm of the number of footnotes; AUDIT ¼ audit
quality; READ_Pages  AUDIT ¼ the interaction variable between financial statements readability and audit quality; SIZE ¼ firm size; ROA ¼ return on assets; LEV
¼ financial leverage; SIGMA ¼ return volatility; RET ¼ average weekly returns; BS ¼ board size; B_INDEP ¼ board independence; BMF ¼ board meetings frequency.
A detailed description of variables is provided in Table 1
Source: Author’s own creation based on the statistical analysis

Correlation matrix
Table 3.
readability
statements
Financial
JFRA (1) (2) (3) (4)
Variables NCSKEWtþ1 DUVOLtþ1

READ_Pages 0.545*** (5.40) 0.531*** (4.43) 0.317*** (5.41) 0.317*** (4.51)

SIZE 0.0198 (0.87) 0.00519 (0.39)
ROA 0.186 (0.61) 0.188 (1.04)
LEV 0.251 (1.62) 0.158* (1.73)
SIGMA 3.327*** (3.79) 1.991*** (3.86)
RET 0.738*** (2.94) 0.469*** (3.18)
BS 0.0780*** (6.88) 0.0394*** (5.92)
B_INDEP 0.130 (0.85) 0.0953 (1.05)
BMF 0.0259*** (3.01) 0.0155*** (3.07)
Constant 2.082*** (5.61) 1.645*** (3.88) 1.249*** (5.80) 0.925*** (3.72)
Year Yes Yes Yes Yes
Industry Yes Yes Yes Yes
Observations 428 428 428 428
R-squared 0.108 0.286 0.111 0.273

Notes: T-values are provided in parentheses; *** and * represent statistical significance at the 1% and 10%
levels, respectively; NCSKEWtþ1 ¼ negative conditional return skewness; DUVOLtþ1 ¼ down-to-up volatility;
READ_Pages ¼ natural logarithm of the number of pages; SIZE ¼ firm size; ROA ¼ return on assets;
LEV ¼ financial leverage; SIGMA ¼ return volatility; RET ¼ average weekly returns; BS ¼ board size;
Table 4. B_INDEP ¼ board independence; BMF ¼ board meetings frequency. A detailed description of variables is
Baseline regression provided in Table 1
results Source: Author’s own creation based on the statistical analysis

Kim et al. (2019) and provide strong empirical evidence supporting our first hypothesis.
Moreover, Kumar (2014) highlighted the pivotal role of the cultural context in shaping the
readability of financial reports, suggesting that companies operating in countries
emphasizing secrecy over transparency may tend to use complex language and vague tones
to obscure information. In Egypt, accounting measurements and disclosure requirements
are generally characterized by a greater degree of secrecy, conservatism and lack of
transparency, as indicated by studies such as Hassan et al. (2009) and Alm El-Din et al.
(2022). Therefore, our findings align with this perspective, underscoring the significance of
cultural context as a determinant of financial report readability.
All models incorporate year and industry effects, with R-squared values 0.108, 0.286, 0.111
and 0.273 for Models 1, 2, 3 and 4, respectively. The relatively low R-squared values of 0.108 and
0.111 in Models 1 and 3 suggest that FSR alone accounts for a modest proportion of the variation
in SPCR. However, with the incorporation of additional control variables in Models 2 and 4, the
R-squared values increased substantially to 0.286 and 0.273, respectively, indicating that the
addition of these control variables enhances the explanatory power of the model.
6.3.2 The moderating effect of audit quality. Table 5 presents regression results
examining the moderating effect of AQ on the relationship between FSR, measured by
READ_Pages, and one-year-ahead SPCR, measured by NCSKEWtþ1 and DUVOLtþ1. The
results demonstrate a significant positive correlation between READ_Pages and SPCR
measures, suggesting that an increase in the number of financial statement pages results in
reduced readability and increased subsequent SPCR. This supports the first hypothesis of
our study regarding the negative relationship between FSR and SPCR. Notably, the
coefficient for AUDIT in both models is negative and statistically significant (p < 0.01),
indicating that higher AQ is linked to lower SPCR. This result is consistent with the findings
reported by Chae et al. (2020), Lim et al. (2016) and Yeung and Lento (2018). Moving on to the
 (1) (2)
Financial
Variables NCSKEWtþ1 DUVOLtþ1 statements
readability
READ_Pages 0.401*** (3.01) 0.235*** (3.00)
AUDIT 0.620*** (3.82) 0.320*** (3.35)
READ_Pages  AUDIT 0.176*** (3.79) 0.0962*** (3.53)
SIZE 0.0226 (0.97) 0.00503 (0.37)
ROA 0.198 (0.65) 0.189 (1.06)
LEV 0.241 (1.57) 0.152* (1.69)
SIGMA 3.374*** (3.90) 2.011*** (3.95)
RET 0.745*** (3.01) 0.471*** (3.23)
BS 0.0753*** (6.70) 0.0377*** (5.69)
B_INDEP 0.123 (0.81) 0.0912 (1.02)
BMF 0.0242*** (2.84) 0.0147*** (2.94)
Constant 1.312*** (2.59) 0.680** (2.28)
Year Yes Yes
Industry Yes Yes
Observations 428 428
R-squared 0.312 0.295

Notes: T-values are provided in parentheses; ***, ** and * represent statistical significance at the 1, 5 and
10% levels, respectively; NCSKEWtþ1 ¼ negative conditional return skewness; DUVOLtþ1 ¼ down-to-up
volatility; READ_Pages ¼ natural logarithm of the number of pages; AUDIT ¼ audit quality;
READ_Pages  AUDIT ¼ the interaction variable between financial statements readability and audit
quality; SIZE ¼ firm size; ROA ¼ return on assets; LEV ¼ financial leverage; SIGMA ¼ return volatility;
RET ¼ average weekly returns; BS ¼ board size; B_INDEP ¼ board independence; BMF ¼ board meetings Table 5.
frequency. A detailed description of variables is provided in Table 1 Moderating effect of
Source: Author’s own creation based on the statistical analysis audit quality

interaction effect (READ_Pages  AUDIT), the findings reveal a positive and significant
relationship with NCSKEWtþ1 and DUVOLtþ1, showing coefficients of 0.176 and 0.0962,
respectively, with a p-value < 0.01. This indicates that the impact of FSR on SPCR is
positively influenced by AQ, implying that higher AQ strengthens the significant
relationship between FSR and SPCR. This suggests that while high AQ enhances investor
confidence and market stability, it also accentuates the negative consequences of complex
financial statements. Hence, AQ is identified as a moderating factor in the relationship
between FSR and SPCR. These results align with the second hypothesis of the study, stated
as H2. Audit quality moderates the relationship between financial statements readability and
stock price crash risk. Both models incorporate year and industry effects, with R-squared
values of 31.2% and 29.5%, indicating a satisfactory fit.

7. Sensitivity analysis and robustness checks

7.1 Alternative variable measurement
To ensure the robustness and consistency of our results, we conducted an additional
analysis using an alternative measure for FSR. While our primary analysis relied on the
natural logarithm of the number of pages (READ_Pages) as an indicator of readability, this
supplementary analysis introduces the natural logarithm of the number of footnotes
(READ_Footnotes) as an alternative measure. The findings in Table 6 demonstrate
remarkable consistency with our baseline regression results in Table 4. Our findings show a
significant positive association between READ_Footnotes and one-year-ahead SPCR
measured by both NCSKEWtþ1 and DUVOLtþ1. This suggests that an increase in the
JFRA (1) (2)
Variables NCSKEWtþ1 DUVOLtþ1

READ_Footnotes 0.707*** (4.93) 0.417*** (4.94)

SIZE 0.0216 (0.99) 0.00670 (0.52)
ROA 0.127 (0.42) 0.154 (0.85)
LEV 0.210 (1.35) 0.134 (1.47)
SIGMA 3.772*** (4.35) 2.257*** (4.44)
RET 0.749*** (3.00) 0.477*** (3.25)
BS 0.0757*** (6.73) 0.0380*** (5.76)
B_INDEP 0.227 (1.47) 0.152* (1.67)
BMF 0.0251*** (2.93) 0.0150*** (2.99)
Constant 2.144*** (4.65) 1.213*** (4.49)
Year Yes Yes
Industry Yes Yes
Observations 428 428
R-squared 0.294 0.280

Notes: T-values are provided in parentheses; *** and * represent statistical significance at the 1% and
10% levels, respectively; NCSKEWtþ1 ¼ negative conditional return skewness; DUVOLtþ1 ¼ down-to-up
volatility; READ_Footnotes ¼ natural logarithm of the number of footnotes; SIZE ¼ firm size; ROA ¼
return on assets; LEV ¼ financial leverage; SIGMA ¼ return volatility; RET ¼ average weekly returns;
Table 6. BS ¼ board size; B_INDEP ¼ board independence; BMF ¼ board meetings frequency. A detailed
Alternative description of variables is provided in Table 1
measurement results Source: Author’s own creation based on the statistical analysis

number of financial statement footnotes results in reduced readability and an increased

likelihood of SPCR in the future. These results reinforce the notion that firms with difficult-
to-read financial statements face increased SPCR in the future, aligning with the central
premise of our study. The consistency observed across alternative measures for both FSR
and SPCR enhances the robustness and reliability of the conclusions drawn in our study.

7.2 Generalized least squares

Based on the Hausman test outcomes, the random effects (RE) method was chosen as an
alternative to the OLS approach. To ensure robustness, the main results outlined in Table 4
were reestimated using the RE effect method. The outcomes, as reported in Table 7,
demonstrate a remarkable degree of compatibility with the OLS results in Table 4. This
reaffirms the stability and reliability of our findings, supporting our first hypothesis, stated
as H1. There is a negative relationship between financial statements readability and stock
price crash risk. These results not only strengthen the validity of our conclusions but also
underscore the overall reliability of our empirical analysis.

7.3 Addressing the endogeneity problem

To address the potential presence of endogeneity issues that could arise from omitted
variables or reverse causality, we adopt a 2SLS approach as a complementary method.
Table 8 displays the results of the 2SLS regression. In the first stage, we estimate the
relationship between FSR (READ_Pages) and the IV (Ave_Pages). The results indicate that
the coefficient of Ave_Pages is statistically significant at the 5% level, demonstrating that
Ave_Pages serves as a valid and relevant IV for predicting variations in FSR. Moving on to
the second stage, we use the predicted values of FSR (READ_Pages_hat) obtained from the
first stage as a proxy for the endogenous variable. The coefficient of READ_Pages_hat in
 (1) (2) (3) (4)
Financial
Variables NCSKEWtþ1 DUVOLtþ1 statements
readability
READ_Pages 0.545*** (4.95) 0.516*** (3.84) 0.317*** (5.00) 0.306*** (3.89)
SIZE 0.0217 (0.83) 0.00660 (0.43)
ROA 0.268 (0.82) 0.241 (1.26)
LEV 0.314* (1.80) 0.206** (2.01)
SIGMA 3.402*** (3.90) 2.056*** (4.02)
RET 0.746*** (3.01) 0.463*** (3.19)
BS 0.0818*** (6.84) 0.0418*** (5.96)
B_INDEP 0.158 (0.93) 0.104 (1.05)
BMF 0.0292*** (3.05) 0.0172*** (3.07)
Constant 2.080*** (5.16) 1.579*** (3.27) 1.249*** (5.37) 0.895*** (3.17)
Year RE Yes Yes Yes Yes
Industry RE Yes Yes Yes Yes
Observations 428 428 428 428
R-squared 0.109 0.285 0.111 0.272

Notes: T-values are provided in parentheses; ***, ** and * represent statistical significance at the 1, 5 and 10%
levels, respectively; NCSKEWtþ1 ¼ negative conditional return skewness; DUVOLtþ1 ¼ down-to-up volatility;
READ_Pages ¼ natural logarithm of the number of pages; SIZE ¼ firm size; ROA ¼ return on assets; LEV ¼
financial leverage; SIGMA ¼ return volatility; RET ¼ average weekly returns; BS ¼ board size; B_INDEP ¼ Table 7.
board independence; BMF ¼ board meetings frequency. A detailed description of variables is provided in Table 1 GLS regression
Source: Author’s own creation based on the statistical analysis results

1st stage 2nd stage

Variables READ_pages NCSKEWtþ1

Ave_Pages 1.091** (2.19)

READ_Pages_hat 11.44*** (4.76)
SIZE 0.100*** (12.62) 1.036*** (4.43)
ROA 0.115 (0.90) 1.803*** (3.43)
LEV 0.163** (2.56) 0.396* (1.81)
SIGMA 0.881** (2.45) 0.312 (0.25)
RET 0.265** (2.55) 0.520** (2.01)
BS 0.00608 (1.30) 0.114*** (8.13)
B_INDEP 0.0250 (0.39) 0.00123 (0.01)
BMF 0.00383 (1.08) 0.0151 (1.27)
Constant 2.472 (1.42) 18.64*** (4.99)
Year Yes Yes
Industry Yes Yes
Observations 428 428
R-squared 0.476 0.291

Notes: T-values are provided in parentheses; ***, ** and * represent statistical significance at the 1, 5 and
10% levels, respectively; NCSKEWtþ1 ¼ negative conditional return skewness; READ_Pages ¼ natural
logarithm of the number of pages; Ave_Pages ¼ average level of financial statements readability within the
industry; READ_Pages_hat ¼ the predicted values of READ_Pages; SIZE ¼ firm size; ROA ¼ return on Table 8.
assets; LEV ¼ financial leverage; SIGMA ¼ return volatility; RET ¼ average weekly returns; BS ¼ board
size; B_INDEP ¼ board independence; BMF ¼ board meetings frequency. A detailed description of Two-stage least
variables is provided in Table 1 squares (2SLS)
Source: Author’s own creation based on the statistical analysis regression results
JFRA the second stage is highly significant at the 1% level. This finding implies that, even after
addressing endogeneity concerns through the 2SLS method, FSR continues to exert a
substantial influence on one-year-ahead SPCR. Therefore, the outcomes of the 2SLS
regression substantiate and fortify the robustness of our conclusions, providing additional
confidence in the relationship between FSR and SPCR.

8. Conclusion, implications, limitations and future studies

The current study set out to explore the association between FSR and SPCR for nonfinancial
firms registered on the Egyptian Stock Exchange. Additionally, it investigates the potential
moderating influence of AQ in this relationship. Through a comprehensive analysis of a
data set and rigorous statistical methodologies, the study seeks to provide valuable insights
into the factors influencing SPCR and the role of FSR in shaping investor confidence and
market stability. The first aim of our study is to examine the effect of FSR on SPCR. The
results reveal a significant negative association between FSR and SPCR, indicating that
companies with difficult-to-read financial statements are associated with higher levels of
SPCR. This underscores the critical importance of clear, readable and accessible financial
information in reducing the probability of sudden and severe stock price declines.
Furthermore, the study identifies AQ as a crucial moderating factor in the relationship
between FSR and SPCR. Higher AQ, typically represented by engagements with Big-4 audit
firms, strengthens the impact of FSR on SPCR. This implies that while high AQ enhances
investor confidence and market stability, it also accentuates the negative consequences of
complex financial statements.
The results provide robust evidence supporting our claim that SPCR can, in part, be
attributed to managers’ opportunistic behavior in presenting less readable (more complex)
financial reports. The link between FSR and SPCR may stem from managers’ attempts to
hide or delay the disclosure of unfavorable information within their financial reports,
leading to an information asymmetry between themselves and investors. As a result,
investors may be unaware of the true financial health and performance of the company,
leading to misperceptions and mispricing of the company’s stock, ultimately resulting in a
stock price crash when adverse information is eventually released. This behavior can be
driven by various motives and incentives, such as the desire to maintain stock prices at
artificially high levels to retain personal benefits, boost managerial reputation or meet
specific performance targets. Moreover, managers may engage in such practices to avoid
triggering market reactions, selling pressure or negative investor sentiment, which could
adversely impact their personal wealth or the company’s value.
Our findings hold significant implications, especially for regulatory bodies and standard-
setting organizations in Egypt. To bridge the gap between theoretical insights and practical
applications, these entities should consider refining and revising existing standards to
underscore the paramount importance of enhancing the readability of financial reports. This
could involve promoting clearer language, standardized formats and measures to reduce the
complexity of financial reports. Based on our review of financial statements and attached
footnotes across the sampled companies, we observed significant variation in both the
quantity and content of the footnotes accompanying the financial statements. Therefore, we
recommend the issuance of sector-specific standardized format guides outlining the number
and content of footnotes to be included with financial statements. These guides would
provide clarity and consistency in financial reporting practices within each sector,
facilitating more meaningful analysis, comparison and readability for investors, analysts
and other stakeholders. We also suggest the Financial Regulatory Authority and the
Egyptian Stock Exchange Administration incentivize companies to issue financial reports
that are easily understandable and readable through mandatory explanatory guidelines, Financial
similar to what the Securities and Exchange Commission (SEC) has done, while also statements
ensuring the availability of mechanisms for examining and evaluating the linguistic
formulation of financial reports in terms of readability. Additionally, there is a need to
readability
develop an index to measure the complexity or readability of financial reports and narrative
disclosures that aligns with the nature of the Arabic language, using updated linguistic
techniques and indices designed for the Arabic language. Moreover, auditing firms play a
crucial role in this process and should actively engage in efforts to ensure clearer and more
transparent financial reporting. This may involve providing guidance to companies on
improving the clarity of their financial statements, conducting training programs for
financial professionals and advocating for best practices in reporting.
Furthermore, the economic and commercial impacts of this emphasis on clearer financial
reporting are substantial. Improved readability has the potential to empower investors with
more comprehensible information, leading to better-informed investment decisions.
Enhanced investor confidence, driven by transparent financial reporting, can contribute to
the strengthening of Egypt’s capital market. This, in turn, not only attracts domestic and
foreign investments but also mitigates potential risks associated with information opacity,
ultimately promoting financial stability. This research prompts further exploration and
discussion on the practical implementation of readability and transparency in regulatory
frameworks and auditing practices, enriching the ongoing discourse within the academic
and professional communities. Our study provides a foundation for continued research and
a basis for shaping future policies that promote clearer and more transparent financial
reporting in the Egyptian context and beyond. It also contributes to a deeper understanding
of the factors influencing SPCR and the mechanisms through which financial information
opacity impacts market dynamics.
Notwithstanding the significant knowledge that may be acquired from this research, its
constraints must be duly acknowledged. First, our sample size is relatively small, which
may impact the generalizability of our findings. Second, this study was conducted within
the Egyptian context, where Arabic serves as the official reporting language. Encouraging
comparative studies across varied linguistic and cultural contexts is recommended to
address this potential limitation. Third, this study focuses exclusively on nonfinancial firms
registered on the Egyptian Stock Exchange, excluding financial companies due to their
unique reporting nature. Fourth, our study concentrates solely on the readability of financial
statements and accompanying footnotes. While this focused approach allows for a more
targeted analysis, it may overlook other sections or disclosures that could potentially impact
SPCR. It is essential to interpret the results of our study within the context of these
limitations, and further research is encouraged to address these constraints.
Given the relatively unexplored nature of the influence of FSR as a determinant of SPCR,
we encourage future studies to delve deeper into the mechanisms through which FSR may
impact SPCR. Specifically, we suggest investigating the mediating roles of information
asymmetry and stock liquidity, which are crucial aspects of financial markets, particularly
in emerging markets. Prior research has indicated that complex financial reports can enable
managers to obscure or conceal unfavorable information, leading to an information
asymmetry between company management and other stakeholders. Moreover, difficult-to-
read financial reports can hinder investors’ ability to interpret and analyze the information
in these reports, consequently reducing their participation in trading activities and,
ultimately, lowering stock liquidity. While prior literature has suggested that information
asymmetry and stock liquidity may influence SPCR, no study has yet examined the indirect
effect of FSR on SPCR through these mediating variables. We believe that investigating
JFRA these mediating roles will not only deepen our comprehension of the relationship between
FSR and SPCR but also underscore the significance of transparent and readable financial
reporting for the stability and growth of financial markets. In addition, we propose
considering the impact of various CG mechanisms as moderating variables in this
relationship, given the increasing emphasis on CG in recent years.
These recommended avenues for future research hold promise for enriching the literature
and offering novel insights that contribute to the advancement of knowledge in the fields
of accounting and finance. Through the examination of these shortcomings, scholars have
the ability to offer significant perspectives for policymakers, regulators and professionals
who are interested in augmenting the efficiency and transparency of financial reporting
practices.

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Corresponding author
Bahaa Saleeb Agaiby Bakhiet can be contacted at: Bahaasaleeb@commerce.aun.edu.eg

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