Easy-to-read financial results lower reliance on outside sources, finds study
For nearly two decades, the SEC has encouraged companies to adopt clear writing in their financial statements through its Plain English Handbook. The document is a useful resource for issuers, although the project cannot be viewed as a complete success; a look at the published literature of US issuers on any given day provides plenty of examples of guff, boilerplate and obfuscation.
But what are the benefits of being more articulate? A new study, published this month in the American Accounting Association’s journal The Accounting Review, argues that clearly written reports reduce investors’ reliance on outside sources and boost the perceived value of companies.
The study authors, based at universities in Iowa, Illinois and New York, asked 203 individuals to read the quarterly earnings release of a hypothetical sporting goods company. Half the reports contained style and formatting encouraged by the SEC, while the other half didn’t. Along with the release, each participant received three analyst comments that were either all positive or all negative about the stock.
The researchers asked the participants to read the release and then give a mark based on how highly they would value the company. The participants did not have to read the accompanying analysts’ statements if they didn’t want to, and 75 relied solely on the earnings release to make their judgment. They were also asked to score the readability of the financial statement.
The findings suggest benefits for companies that stick to plain English. Participants appear to be more influenced by the positive or negative analyst comments when the company’s statement lacks readability. ‘When a firm provides a less readable disclosure, participants feel less comfortable evaluating the firm, and their judgments... are more sensitive to outside sources of information about the firm,’ write the authors.
The study also suggests that writing quality has a direct impact on company valuation. ‘When participants do not access any of the outside sources of information, we find that valuation judgments are lower overall when a firm provides a less readable disclosure,’ say the authors.
The study has some issues. The fact that a large number of participants chose not to read the third-party assessments implies that they are not a great proxy for real investors. Indeed, some of the individuals who took part may not have been financially savvy as, on average, they had each taken only one course in accounting or finance.
So if well-written reports inspire confidence, why do companies continue to obfuscate? The authors suggest this is often not – as is commonly assumed – about hiding negative news and more to do with the difficulty of producing effective writing. Perhaps the study will encourage a few more companies to put the time in. As the authors conclude: ‘What our study makes clear is that failing to make that extra effort is likely to prove costly.’