Study stresses importance of presenting understandable accounting disclosures

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Academic research finds that readable financial disclosures help not only investors, but companies as well.

The study, by Scott Asay of the University of Iowa, W. Brooke Elliott of the University of Illinois at Urbana-Champaign and Kristina M. Rennekamp of Cornell University, found that companies that try to obfuscate negative results with confusing jargon and presentation in their press releases can turn off investors. Instead, investors are more likely to turn to outside sources of information, such as financial analysts, for a clearer explanation of a company’s financial results.

To conduct the study, the professors created two versions of a press release about a fictitious sporting goods company with mixed financial results for the quarter. One version followed recommendations from the Securities and Exchange Commission for presenting financial results more clearly, while the other version did not. The study appears in the July issue of the American Accounting Association's journal The Accounting Review.

The SEC released a “Plain English handbook” in 1998 to encourage companies to write clear SEC disclosure documents in a language that investors could better understand, for example, by using descriptive headers and subheads to break the text into manageable sections and writing short sentences in an active voice.

The researchers then asked two groups of individuals about their reactions to the releases and asked them to rate the fictitious company on an 11-point scale. Each of the two groups of participants had available three media or analyst reactions to the quarterly results that indicated either a uniformly positive or completely negative view of the company's investment potential.

“If managers strategically issue less readable disclosures to obfuscate poor performance, our results suggest investors will respond by increasing their reliance on outside information, at least partially negating this strategic obfuscation,” said the study.

“When a firm provides a less readable disclosure, participants feel less comfortable evaluating the firm, and their judgments about the firm are more sensitive to the content of outside sources of information about the firm,” the study found.

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