A new research article in the Journal of Financial Economics examines the ‘readability’ of shareholder reports, and concludes that firms can increase their market value by improving their readability.
The authors (Byoung-Hyoun Hwang and Hugh Hoikwang Kim) analyze reports using 8 factors identified in the SEC’s 1998 Plain English Handbook as detrimental to readability. Those factors include
- Passive voice
- Weak / hidden verbs
- Superfluous verbs
- Legal and financial jargon
- Numerous defined terms
- Abstract words
- Unnecessary details
- Long sentences
Summarizing their findings, Hwang and Kim underline how “corporate disclosure comes in the form of accounting numbers framed or accompanied by a substantial amount of text.” In the text of the paper itself, the authors observe:
“… annual reports with high readability scores (as per our measure) are associated with more positive moods than annual reports with low readability scores. We also find hints in the data that higher readability generates more trust and higher perceived managerial skill. …”
While governments are not publicly traded, citizens may usefully examine the quality of their disclosure along these lines.
Do governments in weak financial condition exhibit unclear writing in their annual financial reports, compared to governments in relatively good condition?
This morning I looked at the letters of transmittal in the latest annual financial reports for the states of Illinois and Indiana. I counted the number of words, the number of sentences, the number of commas, and the frequency of passive verbs.
Illinois has dug a significantly worse financial hole for itself than Indiana. Coincidentally, or not, the latest letter of transmittal for Illinois shows a higher passive verb frequency and a higher comma/sentence ratio than for Indiana.
How do governments compare to private corporations, in the readability of their annual financial reports?
I just took a look at the annual report for the largest publicly-traded corporation in Illinois, Archer-Daniels-Midland. An analysis of the letter to shareholders results in a ratio of passive to active verbs about one-third the ratio in Indiana, and even lower compared to Illinois.
An incomplete analysis, to be sure. But focusing on the active vs. passive voice provides a good start, for a few reasons. Consider observations in The Writer’s Handbook, including …
“Passive voice sentences often use more words, can be vague, and can lead to a tangle of prepositional phrases.”
… and …
"In a sentence written in the active voice, the subject of sentence performs the action. In a sentence written in the passive voice the subject receives the action."