Less Readable Disclosures Can Turn Off Investors

Jul 25th 2017
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Nearly 20 years after the US Securities and Exchange Commission (SEC) issued a “plain English handbook” to help investors decipher corporate disclosure documents, new research indicates that disclosure readability also helps companies – perhaps more so.

The study, Disclosure Readability and the Sensitivity of Investors’ Valuation Judgments to Outside Information, which was published in the July issue of the American Accounting Association Journal, The Accounting Review, reveals that less reader-friendly disclosures make investors uncomfortable and more inclined to use outside information about the company.

What’s more, “even when participants do not access any of the outside sources of information, we find that valuation judgment is lower overall when a firm provides a less readable disclosure,” the study states.

Why? Because the less readable the disclosures are, the more likely they are to derail how well managers can convince investors that future performance will improve, the study states. In turn, investors will be more likely to disregard managers’ optimistic portrayal of the company’s future and put greater value on outside information sources.

That backfires even further, according to the study’s authors.

“If managers strategically issue less readable disclosures to obfuscate poor performance, our results suggest investors will respond by increasing their reliance on outside information, at least partially negating this strategic obfuscation,” say authors H. Scott Asay of the University of Iowa, W. Brooke Elliott of the University of Illinois, and Kristina M. Rennekamp of Cornell University.

But here’s the catch-22: The more readable corporate disclosures are, the more likely they’ll benefit the company as much as investors. That’s because investors will be more inclined to rely on the corporate disclosures than outside information.

So the bottom line is this: When financial results are mixed, readability can foster a positive impression regardless of whether investors read outside opinions.

The bigger question goes back to the 19 years of SEC readability lessons: How come they are absent in many corporate disclosures? They were intended, after all, to use formatted and linguistic tactics, such as descriptive headlines and subheadlines, to break the text into more easily digestible pieces. Sentences also were short and written in the active voice.

Study co-author Asay puts it this way: “Scholars have assumed a major reason is that managers intentionally prepare less readable disclosures when company performance is poor. In general, though, poor readability probably has less to do with deliberate obfuscation than with the inherent difficulty of producing readable narratives of any kind and the much greater effort required when performance leaves something to be desired.”

What the study makes clear is that failing to make that extra effort is likely to prove costly, he said.

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