Bogging down investors

In an ideal scenario, corporate disclosure documents are a helpful and important tool for investors – providing news, data and operational details that allow them to make informed decisions.

But as a researcher with a decade of experience analysing the text of corporate disclosures, Alberta School of Business professor Ke Wang has witnessed firsthand the trend towards increasingly lengthy and complex financial reports.

In his latest study, which has been published in the latest issue of Contemporary Accounting Research (Volume 42, Issue 2), Wang focuses on a specific area of concern: the connection between litigation risk and the readability of disclosure documents.

“The question we wanted to answer was very simple: would the risk of firms being sued by their shareholders shape their disclosure feature?” says Wang, who co-authored the study with Siwen Fu, Liandong Zhang and Liu Zheng.

In order to undertake their analysis, Wang and his colleagues examined the effect of the 1999 Silicon Graphics Inc. (SGI) court ruling, which unexpectedly reduced litigation risk for firms within the Ninth Circuit Court’s jurisdiction in the United States.

They found that, compared to firms in other circuits, disclosure documents in the Ninth Circuit experienced a relative improvement in readability.

Wang explains that when companies are overly concerned about litigation risk, the documents they produce become more like legal documents than communication tools, which is far less useful for investors.

Features that make documents less readable include everything from very long sentences and little variation of sentence length to the heavy usage of both business and legal jargon.

Wang draws a parallel between investors’ experiences navigating these corporate documents and the everyday experience of trying to understand the documents that accompany credit cards.

“They’re full of legal terms and we never read them,” he says. “But if we have a problem and try to sue the company, we may find there is a legal disclaimer or some cautionary statement in very small font size in their document that prevents us from doing so.”

According to Wang, the findings of their study are significant because the improved readability of reports has many benefits. These include reduced information processing costs, an enhanced information environment and a landscape that is ultimately better for both investors and the market.

While their research suggests that a decrease in lawsuits is beneficial, Wang stresses that the underlying message is not that all litigation is bad.

“Litigation was designed to protect investors,” he explains. The real problem lies with the prevalence of frivolous lawsuits that put companies on the defensive as they try to avert the risk of being targeted.

“If we increase the cost, or just make sure that dismissing frivolous lawsuits is faster and more efficient, then it could stop lawyers from pursuing them,” Wang observes.

Read Ke Wang's full research article at doi.org/10.1111/1911-3846.13027

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