Exploring the Going Concern Statement, Readability and Length Cues as Indicators of Distress at Italian Companies

ABSTRACT

This study explores the going concern statement, readability and length cues as indicators of Italian private companies in default. The results indicate that the disclosures of defaulting companies contain (1) low readability; (2) greater uncertainty and confusing information; and (3) a lengthy going concern statement compared to non-defaulting firms. This is the first study to analyse the going concern statement and its correlation with Italian default by comparing International Financial Reporting Standards (IFRS) and Italian Generally Accepted Accounting Principles (GAAP).

Keywords:

• Italy
• corporate narrative disclosures
• going concern
• distress indicators

Acknowledgments

The authors thank the participants of the 2015 annual conference of Financial Reporting and Business Communication for their helpful comments. The authors acknowledge funding from the University of Regina, Faculty of Business Dean’s Research Grant, and the Université de Sherbrooke, School of Business Research Grant.

Disclosure Statement

No potential conflict of interest was reported by the authors).

Notes

1 Previous studies obtained various accuracy levels: e.g. Tennyson et al. (1990) highlight an accuracy level of up to 85–95%, while Danovi and Quagli (2012) indicate accuracy levels between 50% and 85%.

2 Financial distress, default and bankruptcy are primary stages in the life cycle of firms (Wruck, 1990; Koh et al., 2015). Distress can lead to forced liquidation or bankruptcy. Numerous studies equate financial distress with likelihood of bankruptcy (Altman, 1968; Altman et al., 1977), while other studies consider defaulting firms to be distress-bankrupt firms (e.g. Lin et al., 2012) given their degree of correlation (Beneish & Press, 1995). In this study, failure is defined as winding up by court order and is captured through the Altman Z-score (Z < 1.23). We use default, distress, failure, and bankrupt interchangeably.

3 The financial reports of Italian companies, essentially family-owned organizations, are particularly directed to creditors’ needs. Creditors include banks, suppliers, and workers. Banks have access to inside information, but suppliers do not. During the economic crisis, many outstanding companies failed after some years because their major clients failed and thus stopped payments, creating a vicious cycle. If suppliers would have been informed about their clients’ crisis conditions in a timely manner, they would have stopped sales on credit and avoided their own crisis.

4 Opportunistic behaviour in financial reporting is more complicated, especially figures, than manipulating narrative disclosures, and it brings an increased risk of fraud.

5 The four maxims of IMT are quantity, quality, manner and relation. Our study focuses on readability and clarity information, which falls under the quantity and manner maxims. We do not discuss the other two maxims as they are not relevant to this study. Future research could examine quality and relation maxims.

6 Private companies were selected because they can choose between IAS-IFRS and Italian accounting standards, whereas Italian public companies have been obligated to use only IAS-IFRS since 2005.

7 AIDA is a database of Italian firms. It can be found at https://aida.bvdinfo.com/version-2017116/home.serv?product=AidaNeo.

8 The sample size could be a limitation for broad generalization.

9 Although combining the notes and MD&A sections provide the full picture of going concern assessment and underlying conditions, it could be a limitation for measuring length. Some researchers consider merging the two sections could be an issue as the sections could be saying similar things with different words therefore the length measure would be duplicating the effect. However, in our study the risk of duplication is infinitely low because the issue has been arisen only in two cases and has been solved.

10 We considered only the first tier because financial statement readers are most probably high school graduates.

11 Italian keywords are: continuità aziendale (going concern), liquidazione (liquidation), crisi economica (economic crisis), grave tensione finanziaria (severe insolvency).

12 The examples were translated from Italian to English.

Additional information

Funding

This work was supported by Université de Sherbrooke, School of Business Research Grant; University of Regina, Faculty of Business Dean’s Research Grant.