Study: Foreign Company Disclosure Clearer, More Transparent

As the Securities and Exchange Commission commences a sweeping review of its disclosure regime, its staff may want to cast their eyes overseas: A new study finds that foreign companies listed on U.S. exchanges make disclosures that are clearer and less repetitive.

In fact, the further away a company’s headquarters is, the clearer the company’s filings in the United States, says Russell Lundholm, a professor of accounting at University of British Columbia’s Sauder School of Business. The same holds for other investor communications, such as earnings releases.

Lundholm and his colleagues—Rafael Rogo and Jenny Li Zhang—pored through the SEC filings and investor-targeted press releases of foreign companies listed on U.S. stock exchanges in an effort to assess their clarity. The result is their soon-to-be-published paper, “Restoring the Tower of Babel: How Foreign Firms Communicate With U.S. Investors.”

What they found was surprising. Consistently clearer disclosures came from unexpected countries: Russia, Argentina, Venezuela, Greece, and Indonesia. The research also found that the further away a country is from the United States, the more effective its disclosures tend to be.

The catalyst for this dig into disclosures was curiosity about the phenomenon known as “home bias,” where investors seldom invest in companies that aren’t identified as domestic. “Why do investors not hold a global portfolio?” Lundholm asks. “Are the accounting rules the same or different? Is investor protection the same or different? Is it just those foreign companies are foreign and seem more distant?”

Beyond assessing disclosures with established readability indexes, the researchers settled on their own approach: the number of numbers. “I read lots of Management Discussion and Analysis (MD&A) sections and a good one for me is one where I see lots of numbers and lots of factoids presented and quantified,” Lundholm says. “So we landed upon counting up the number of numbers. That works for a couple of reasons. Numbers are universal, so language isn’t an issue—10 is 10 all around the world. They are also precise and likely candidates if you are trying to be clear and crisp in your communications.”

That idea, although easily stated, was “a nightmare” to execute, Lundholm says. While it might be easy, but time consuming, for a human to sit down with an MD&A and circle all the numbers, it was very hard to find a way to automate that search. Another obstacle is that, in many cases, numbers were spelled out. Lundholm says the solution came from using the XBRL accounting standard and tagging that indicates tables.

Number Crunching

The researchers also sought to control for the length and inherent complexity of the filings. “Bigger companies with more segments will have more numbers,” Lundholm says. “That’s not really surprising. So, we controlled for how long the document was in words and numbers. Ideally, we wanted to find two equally complex firms where one provides a lot more numbers than the other.”

The most surprising finding, one that continually bore out no matter how the data was parsed, is that distance correlates to clarity. “A lot of folks with a U.S.-centric view of the markets would be fairly surprised to see that the further you go away from this country, the better the disclosures,” Lundholm says. “In the United States, we just assume they would be bad. But on both number of numbers and clarity, the U.S. is worse than the typical foreign firm.”

The researchers say the attempts by foreign issuers listed on U.S. exchanges to provide more clarity has to do with them trying to overcome that home bias. He says U.S. investors start with an idea that foreign companies are more difficult to understand.  “There is a psychological answer to all of this too, which is the notion that as things become more distant from your immediate experience you conceive of them more abstractly,” he adds of home bias. “It is not just that I don’t know what is going on in a foreign country, and what their accounting rules are and things like that, my conceptions of them are just more abstract.”

“One of the most enduring results of home bias literature is that the size of the bias varies with the geographic distance from the U.S., between the investor country and the foreign country,” he adds. “The fact that the communication effort varies is pretty strong evidence that the foreign companies see this bias that they face and are trying to do something to overcome it. Remember, these are foreign companies that have arrived on the shores of the United States with traded equities. I may not trust just any old company in China, but I might trust the ones that have shown up in the U.S. markets.”

The Tower of Babel

The following is from the academic paper “Restoring the Tower of Babel: How Foreign Firms Communicate with U.S. Investors,” a look at how disclosure readability varies by country.

Foreign companies that trade their equity in the U.S. face serious obstacles. They must comply with a complex set of SEC disclosure requirements, including the mandate to provide a meaningful Management Discussion and Analysis (MD&A) of their operating results. Their home country may speak a different language, use different accounting rules, and offer different types of investor protection than the US, and each of these differences presents a friction that must be mitigated in order to attract US investors. Given these cultural, procedural and linguistic differences, one might expect that the disclosures of foreign firms would be of lower quality than their US firm counter-parts. In this paper, we present the surprising result that foreign firms traded in the U.S. present more numerical data and write more readable text in their MD&A than comparable U.S. firms.

The SEC has repeatedly expressed concern about the readability of mandatory filings. In several releases after the Securities and Exchange Act of 1934, the SEC has encouraged clearer communication. The Wheat Report in 1969 complained about needlessly complex language and called on companies to improve the clarity of their disclosures. In 1998 the SEC issued the Plain English disclosure guidelines for all prospectuses in registered public offerings by domestic and foreign issuers, and produced a Plain English handbook on how to write clear SEC documents. More recently, SEC chairman Christopher Cox suggested that the SEC may someday use a readability measure such as the FOG index to assess compliance with the Plain English rules.

Nowhere is management communication more important than with foreign SEC registrants. Their operations are outside the US, making the mandated discussion in the SEC filings a primary source of information about the firm. Not only do we find that foreign firms produce more readable reports than U.S. firms, we find that readability increases with the geographic distance from the U.S.

Source: “Restoring the Tower of Babel.”

Lundholm doesn’t think the push for clarity among foreign companies is accidental. “Firms that have arrived and are issuing equities in the U.S. didn’t just fill out a form. They hired lots of professionals to work with them and were told they have a bias to overcome. So, they are actively trying to overcome that bias and are choosing to do it with better communication in their MD&A sections and press releases.” The goal for foreign companies, he says, is to present information simply and clearly. U.S. companies often give in to the temptation to “obfuscate with flowery language.”

Plainer Language, Please

What can U.S. companies learn from their foreign counterparts? “There is a push for what the SEC calls its plain language initiative,” Lundholm says. “It is trying to stamp out some of the confusing, vague flower language, but I don’t think they are succeeding. What we see is that people respond to clear writing and lots of numbers. For investor relations inside the United States, one thing you can do is write clearer and present more numbers.”

Lundholm isn’t optimistic, however. “I don’t anticipate the United States changing its ways much,” he says. “The MD&A sections and press releases are crafted by investor relations and legal offices; they go back and forth between them. So it is not surprising the net result is a bit hard to follow.”

As for that much-talked about top-down disclosure review underway by the SEC, Lundholm thinks it has a formidable task on its plate. “The SEC has a long ways to go,” he says. “The number of redundant disclosures in a 10-K is mind-boggling. There are whole pages that are repeated over and over again because somebody added a new requirement and it just got taped in. You never know if this is a new fact, or the same fact over again, or maybe you misunderstood the fact the first time you saw it.”