Why are corporate reports hard to read?

by on June 22, 2006 at 6:32 am in Economics | Permalink

Apparently there’s a simple reason why annual reports are hard to
read: managers, in many cases, are trying to hide something.

The study, Annual Report Readability, Earnings and Stock
Returns
, found that the annual reports of underperforming
companies are harder to read than those of companies that are
performing well.

Feng Li, an assistant professor of accounting at the university,
measured annual report "readability" using a sample of more than
55,000 company reporting years. He examined syllables per word and
words per sentence in reports filed with the Securities and
Exchange Commission.

He used two readability measures.

First, the "Fog Index" indicated the number of years of formal
education a reader of average intelligence would need to read the
text once and understand it. Fog = (words per sentence + per cent
of complex words) x 0.4. Complex words were defined as words of
three syllables or more.

Second, the Kincaid Index rated the reports on a US primary
school level.

According to the study, annual reports of companies with lower
earnings were more difficult to read. Similarly, companies that had
volatile earnings were more likely to produce abstruse reports.

Here is the full story.  The bad companies might be obfuscating.  Alternatively, poor quality production might be correlated with poor quality writing.  Thanks to Natasha for the pointer.

1 Josh June 22, 2006 at 8:41 am

I wonder if there is also a correlation between underperforming companies and font selection/size (for a printed report) and/or ability to find and read (for an online report).

2 Eric Rasmusen June 22, 2006 at 10:45 pm

Another explanation: bad news is more complicated, especially unexpected bad news.

Volatile earnings also need more explanation.

I would expect a company with an unusually good year also to
have a more complicated report.

And, perhaps most directly: if a company writes off an entire investments, that will cause both low earnings and a need to explain what happened–even
though what happened had been slowly occuring for years, and just is recogneized by standard accounting principles all at one time.

3 linda October 10, 2006 at 8:37 am

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