Watch Your Language: The Value of Clarity
In investor communications, good writing can attract investors and enhance share prices.
When considering potential investments, people care only about the numbers: a fund’s returns, a firm’s profits. Right?
Wrong. The words that accompany those numbers speak volumes. “The language around these disclosures is what actually gives the performance some meaning to investors,” says Kristina Rennekamp, assistant professor of accounting at Johnson. The good news: Plain talk is the most understandable — and persuasive.
In research conducted independently of one another, Rennekamp and her Cornell SC Johnson College of Business colleague, Byoung-Hyoun Hwang, assistant professor of finance at Dyson, along with their co-researchers, have found that the words in a prospectus or shareholder report can strongly affect people’s willingness to invest in a firm, how much readers believe a firm’s claims, and even a fund’s share price.
Perception is reality
Research into language and its effects on investors isn’t new, but Rennekamp and Hwang wanted to explore fresh angles. Rennekamp was intrigued by the Securities and Exchange Commission’s (SEC) efforts to help firms write better, such as the Plain Writing Act (2010) and Plain English Handbook (1998). Presenting study participants with stock prospectuses that emphasized either concrete or abstract language, she found that concrete language made people more likely to invest (“Does Concrete Language in Disclosures Increase Willingness to Invest?” with W. Brooke Elliott, University of Illinois, and Brian J. White, University of Texas, Review of Accounting Studies 20.2, 2015).
“Wouldn’t people just go somewhere else to find information they can understand?”
Curious about other researchers’ speculations that firms intentionally write badly to obscure poor performance, Rennekamp conducted further research (“Disclosure Readability and the Sensitivity of Investors’ Valuation Judgments to Outside Information,” with Elliott and H. Scott Asay, University of Iowa, The Accounting Review, 2016). “I thought, ‘Wouldn’t people just go somewhere else to find information they can understand?’” She confirmed her suspicions: When participants in this study read a badly written firm prospectus, they relied more on outside sources to help them decide whether to invest.
“If I write poorly, will investors punish me?”
For his research, Hwang asked another question: “If I write poorly, will investors punish me?” To find out, he and his co-author studied the readability of annual reports for 92 closed-end equity funds between 2003 and 2013 (“It Pays to Write Well,” with Hugh Hoikwang Kim, University of South Carolina, Journal of Financial Economics, 2017). “When there’s a 10 percentage point increase in the number of writing faults per sentence, funds on average trade at about a 2.7 percentage point greater discount,” says Hwang.
Echoes of our high school English teachers
Rennekamp and Hwang took many of their good writing tips from the Plain English Handbook, which offers excellent guidance, including: Keep sentences short; avoid the passive voice, weak verbs, and jargon; don’t be wordy; limit terms that have to be defined; be concrete. They offer a few more pointers here:
- Keep it simple, stupid (KISS). The principles of good writing boil down to common sense. “Construct simple sentences that your readers can process easily,” says Hwang. Cull the jargon and legalese. Lots of passive voice, longwindedness, and modifiers make a reader’s eyes glaze over. For example, compare these sentences: “No person has been authorized to give any information or make any representation other than those contained or incorporated by reference in this joint proxy statement/prospectus.” Versus “You should rely only on the information contained in this document.”
- Picture your reader. Warren Buffett, in his preface to the Plain English Handbook, urges writers to pretend they’re addressing a specific person — say, an intelligent, interested sibling who isn’t a financial expert. When in doubt, Hwang suggests, err on the side of simplicity. “At least based on our evidence, it doesn’t seem like investors punish you for constructing ‘baby sentences,’” he says.
- Be concrete. Concrete statements tend to be easier to visualize than abstractions (compare “Jim attends church weekly” with “Jim is devout”). When research participants read a stock prospectus with concrete language, they felt more comfortable and more willing to invest. “There’s all this evidence that people are biased toward firms that feel more familiar to them,” says Rennekamp.
- Don’t try to hide bad news with poor writing. “Based on our evidence, you will be punished for bad writing,” says Hwang. As Rennekamp found, poor writing sends people to look for outside information. Worse yet, “When investors can’t process a text easily, they’ll trade you at a discount,” says Hwang.
- Run a writing “spell checker.” Rennekamp points out that Stylewriter, a copyediting software that Hwang used to “grade” the annual reports in his study, is excellent for improving writing. “If you have an important document, run it through copyediting software to check for clarity and readability. That can make a huge difference in how effective a communicator you are.” Many researchers do this with their papers before submission, she says: “It’s the same idea: You’re going to be more convincing with your research if people can understand what it’s saying!”
- Change small things to make a big difference. Some firms may balk at expending effort on writing for various reasons: because they feel they lack the staff, or because they want to address only those documents required by the SEC to contain “plain language.” But Hwang and Rennekamp emphasize that the benefits of writing well make it worth the effort. “Small firms, especially because they may be less familiar to people in the first place, may have to work harder to establish their credibility with people,” Rennekamp remarks. “If they can communicate more clearly, that definitely makes them seem more credible and professional.”
Rennekamp adds a piece of advice to investors — caveat emptor: Good writing can hide poor results. When participants in Rennekamp’s study read a well-written prospectus, they tended not to seek outside information — at the risk of overlooking bad news. “If what the firm is saying is so clear and convincing — say performance is poor but the manager gives a really clear, slick explanation and convinces you that things will turn around — and you don’t dig deeper to see if there are some fundamental problems, that could be bad for you,” adds Rennekamp.
Stronger share prices and happier investors are incentive enough, but the icing on the cake is that writing well is easy. “I’m continually surprised by how such little differences [in phrasing] can cause pretty big differences in how stakeholders feel about a company,” says Rennekamp. “We’re not changing the content of the disclosures; we’re just changing tiny little style words, and that actually affects people’s investments — which could be thousands or hundreds of thousands of dollars.”
“Disclosure Readability and the Sensitivity of Investors’ Valuation Judgments to Outside Information,” Scott Asay, Kristina Marie Rennekamp, and W. Brooke Elliott, The Accounting Review, (2016)
“Does Concrete Language in Disclosures Increase Willingness to Invest?” W. Brooke Elliott, Kristina Marie Rennekamp, and Brian J. White, Review of Accounting Studies,20.2 (2015): 839–865
“It Pays to Write Well,” Byoung-Hyoun Hwang and Hugh Hoikwang Kim,Journal of Financial Economics, 124 (2017): 373–394