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Straight talk equals good business

Scott Tong Sep 27, 2006

KAI RYSSDAL: All that talk of a record on the Dow aside, we’re about to get into the truly crazy time on Wall Street. When being off by just a penny on a profit report can cost a company millions in shareholder value. We go through it once a quarter. It’s called earnings season. Accounting departments all over corporate America pull out their best business speak to confound Wall Street and individual investors alike. For most of us the documents are hopelessly opaque. But a new report from the University of Michigan suggests they’re not all the same. That companies that speak regular English might actually perform better. Marketplace’s Scott Tong read the fine print.

SCOTT TONG: Linguists have a measuring stick for readability — it’s called the FOG index. The longer the sentences, the bigger the words, the foggier something is. For instance, at the low end of the scale, Dr. Seuss:

We looked and we saw him! The Cat in the Hat!

In the middle of the range: Time Magazine, and most novels. And at the foggy end are corporate annual reports, just about off the charts. Here’s an example, courtesy of airline analyst Richard Aboulafia.

RICHARD ABOULAFIA: One consumer of aircraft came up with this gem: “From executive compensation packages that more closely align pay to company performance to newly instituted employee reward programs that . . .


ABOULAFIA: Now they had just dropped the company pension plan. That’s a good way of putting a face on it, I suppose.

Now it turns out there’s dense, and then there’s super dense. Michigan accounting professor Feng Li analyzed 40,000 annual reports. He found that companies doing poorly tend to write more opaquely.

FENG LI: You look at two companies, they report the same amount of earnings this year. But one has a more complex annual report. So chances are, this company will have lower earnings in the future. So something bad is going on.

So why are struggling firms more obtuse? Study author Li thinks it’s deliberate — to hide the truth.

LI: The evidence seems to suggest managers are trying to fool the stock market investors by reporting foggy annual reports.

The study found that executives who own company stock — or have the option to buy them — write foggier reports. Li says they’re propping up the price for personal gain. Not everyone’s so cynical.

ROB BLOOMFIELD: It isn’t easy to look good while you’re reporting bad news.

Rob Bloomfield teaches accounting at Cornell.

BLOOMFIELD: If I get home when I said I would, all I have to tell my wife is, honey I’m home. It’s a short sentence and small words. If I get home late, the truth always seems a lot more complicated. And I end up using sentence structures and verb tenses I didn’t even know I knew.

The other thing going on here, is giant words and sentences tend to show up when attorneys do. Brad Hintz of Sanford Bernstein used to help write reports for big brokerage firms.

BRAD HINTZ: When things are good, the annual report tends to be written by the head of investor relations, who tends to be a public relations type person. When things are bad, you get teams and teams of lawyers involved, and they seem to like 50 cent words.

And arguably, for good reason. Firms that lose money get sued more — so they need to protect themselves, with long versions of “your mileage may vary.” Again, analyst Richard Aboulafia.

ABOULAFIA: Lawyers getting involved in an annual report produces something like the inserts you get with a prescription drug. You get these incredibly long passages, how it may cause hair loss and vomiting, but it probably won’t. In other words they have to really prepare for any contingency.

So let’s say the study is right, that companies that are short on earnings are long on rambling. You might be tempted as an investor to bet against them and put your money on the clear talkers. Michigan’s Li says don’t bother — that professional stock pickers have already done that.

You might say the BS is priced in.

I’m Scott Tong for Marketplace.

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