Hey, CEO: English Class Counted -- WSJ
April 10 2017 - 3:03AM
Dow Jones News
By Daisy Maxey
Good writing is its own reward -- at least when it comes to
companies' annual reports, say two researchers who studied its
importance.
There's evidence that poorly written annual shareholder reports
cause companies to trade at significant discounts to their
fundamental value, say researchers Byoung-Hyoun Hwang, assistant
professor of finance at the Dyson School of Applied Economics and
Management in Cornell University's SC Johnson College of Business,
and Hugh Hoikwang Kim, assistant professor of finance at the
University of South Carolina's Darla Moore School of Business, in a
new paper.
Their research shows that firms for which there is relatively
little public information "can meaningfully increase their market
value by increasing the readability of their annual reports," says
Mr. Hwang.
Active vs. passive (verbs)
The two used the copy-editing software StyleWriter to count the
most important writing faults in the annual shareholder reports of
96 closed-end stock funds. Messrs. Hwang and Kim searched the
reports for five of the eight language-related factors that the
Securities and Exchange Commission mentions in its handbook on
creating clearer disclosure documents.
The traps to avoid: legal words, hidden verbs, passive verbs,
overwriting and wordy phrases.
Closed-end funds trade on exchanges like stocks, and can trade
at a discount or a premium to the underlying value of the
securities they hold.
The researchers found that "closed-end funds with less easily
readable reports trade at greater discounts relative to closed-end
funds with more easily readable annual reports," says Mr. Hwang.
"In particular, our analysis suggests that a 10 percentage-point
increase in the number of writing faults per sentence, on average,
increases the closed-end fund discount by 2.7 percentage points,"
he says.
The two focused on closed-end funds because there's so little
public information on the funds that it's likely that the
shareholder reports are the primary source of information for
shareholders, and because closed-end funds are primarily held by
individual investors, says Mr. Hwang.
"We're actually not sure to what degree our findings extend to
large, visible firms, such as Apple Inc.," he says.
Because closed-end funds' discounts or premiums can be affected
by factors other than the readability of their annual reports, such
as liquidity, managerial skill and investor sentiment, the two
sought to control for those factors.
Their data suggest that "higher readability generates more trust
and higher perceived managerial skill," Messrs. Hwang and Kim say.
They write, "When a firm's annual report becomes difficult to read,
investors become suspicious, perceive the firm and its managers to
be of lower quality or subconsciously develop negative
sentiments."
"The results strongly suggest that investors value clear and
concise communication," says Mr. Kim. "If annual reports or
corporate disclosure documents are written in a complex way,
investors will trade the firm at a discount."
Erik Herzfeld, president of Thomas J. Herzfeld Advisors Inc., a
Miami advisory firm specializing in managing money in closed-end
funds, says that only a small amount of closed-end funds hold
quarterly calls for shareholders and that the funds garner little
analyst coverage or attention from the media, making reports more
important to investors. However, some large fund companies, such as
Putnam Investments, Pacific Investment Management Co. (Pimco) and
Nuveen investments, do post a lot of information on their funds on
their websites, he says.
Research 'makes sense'
The researchers had a small sample size, but "it makes sense --
all things equal -- that it would make a difference whether a
shareholder letter was well-written or not," says Mr. Herzfeld. "I
am not surprised that this could affect the discount."
It's also possible that closed-end funds with well-written
shareholder reports may trade at smaller discounts or at premiums
simply because they're from bigger fund complexes with more
resources at their disposal, he says.
"This affords them larger compliance departments and dedicated
proofreading services," he says.
Ms. Maxey is a reporter for The Wall Street Journal in New York.
Email her at daisy.maxey@wsj.com.
(END) Dow Jones Newswires
April 10, 2017 02:48 ET (06:48 GMT)
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