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Hey, CEO: English Class Counted -- WSJ

10/04/2017 8:03am

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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


(END) Dow Jones Newswires

April 10, 2017 02:48 ET (06:48 GMT)

Copyright (c) 2017 Dow Jones & Company, Inc.

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