Corporate news releases that report financial results in difficult-to-read prose can be misleading to investors, according to a new study.
Financial writing has been criticized for being unclear and opaque, but the research published in The Accounting Review, the journal of the American Accounting Association, demonstrates that poorly-written press releases can actually be used to manipulate investors.“The greatest danger to investors may not be low readability per se but that managers can use it opportunistically to obfuscate unfavorable benchmarks while embracing clarity for favorable ones that are less important,” co-author Elaine Ying Wang of the University of Massachusetts Amherst said in a (relatively intelligible) news release.
The study details an experiment in which the researchers asked 131 MBA students to read a four-paragraph quarterly earnings press release.
The first two paragraphs of the release spelled out in plain language either success or failure in meeting previously issued management guidance, and the fourth paragraph consisted of a pro-forma sentence expressing confidence in the company and its future. The heart of the experiment was the third paragraph, which compared key aspects of financial performance in the current quarter (sales, earnings, etc.) with those of the year-ago quarter.
In a version of the release read by half the participants, the financial results were predominantly positive, while in a version read by the other half they were mainly negative. The results, whether good or bad, were presented either in easy-to-read charts and bullet points or in murky prose.
Where the first two paragraphs were not consistent with the third paragraph — for example, the company met analysts’ forecasts but reported lower earnings than a year earlier — “the readability of the key third paragraph became critical,” the study says.
If the readability of paragraph three was high, participants rated the strongly performing company far higher than the weakly performing one. But when readability was low, the weakly performing firm actually rated slightly higher than the strong performer.
According to Wang, the lesson is investors shouldn’t assume that just because an earnings release is “hard to read it isn’t important. That may very well be what some devious manager is counting on you to think.”