Investors reward readable disclosures, study finds

It turns out investors really do value and reward plain-English disclosures.

An academic study soon to be published in the American Accounting Association’s professional journal says companies that provide less readable disclosures leave investors less comfortable in their assessment or evaluation of the company as a prospective investment.

What’s more, investors left somehow unsatisfied by less readable disclosures are more sensitive to outside sources of information about the company. And even if they don’t seek out that additional outside information, such investors tend to provide lower overall value to those companies.

The authors of the study say their findings poke holes in a prevailing notion in financial management that says the way to hide poor financial results is in poorly written disclosures. The study finds complicated, legalistic disclosures that are less readable to investors make it more difficult for the company’s disclosures to convince investors that future performance is likely to improve.

That’s what inspires investors to turn elsewhere for information, the study says. "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,” the report says.

On the flip side, the study also finds when investors are satisfied with readable, easy-to-digest disclosures, they may put their pencils down and rely on those disclosures without turning to any outside information. That suggests the company benefits even more from plain-English disclosures than the investors who rely on them, the study says.

The findings are based on an experiment involving more than 200 prospective investors reviewing disclosures from hypothetical companies regarding sales and earnings in a recent quarter. Materials contained the same disclosures, but only some adopted formatting and linguistic features that have been suggested by the Securities and Exchange Commission to promote readability.

The SEC’s plain-English handbook, issued in 1998, says companies should use descriptive heads and subheads to break up text, and write short sentences in an active voice. Study participants who looked favorably on an investment option without reading outside assessments said they were impressed by materials that were more readable, the authors said.

Both the Financial Accounting Standards Board and the SEC are in the midst of long-term projects to make disclosures in financial statements more effective.

The co-authors of the study are H. Scott Asay of the University of Iowa, W. Brooke Elliott of the University of Illinois at Urbana-Champaign, and Kristina M. Rennekamp of Cornell University.