Research: Simple Writing Pays Off (Literally)

When SEC Chairman Arthur Levitt championed “plain English” writing in the 1990s, he argued that simpler financial disclosures would help investors make more informed decisions. Since then, we’ve also learned that it can help companies make more money.

Researchers have confirmed that if you write simply and directly in disclosures like 10-Ks you can attract more investors, cut the cost of debt and equity, and even save money and time on audits.

A landmark experiment by Kristina Rennekamp, an accounting professor at Cornell, documented some of the consequences of poor corporate writing. Working with readers of corporate press releases, she showed that companies stand to lose readers owing to lousy “processing fluency” of their documents. “Processing fluency” is a measure of readability used by psychologists and neuroscientists.

Rennekamp asked people in an experiment to evaluate two versions of financial press releases. One was the actual release, from a soft drink company. The other was an edit using simple language advocated by the SEC’s Plain English Handbook. The handbook, essentially a guide to better fluency, contains principles that now serve as a standard by which researchers measure readability.

Published under Levitt, the handbook clarified the requirements of Rule 421, which, starting in 1998, required all prospectuses (and in 2008 all mutual fund summary prospectuses) to adhere to the handbook’s principles. Among them: Use short sentences. Stick to active voice. Seek concrete words. Shun boilerplate. Minimize jargon. And avoid multiple negatives.

Rennekamp’s experiment, using the so-called Fog Index, a measure of readability based on handbook standards, provided evidence that companies would do better at hooking readers if they simply made their writing easier to read. “Processing fluency from a more readable disclosure,” she wrote in 2012 after measuring the greater trust readers put in well-written releases, “acts as a heuristic cue and increases investors’ beliefs that they can rely on the information in the disclosure….”

Subsequent studies have gone outside the lab to quantify the harm associated with overly complicated writing in real-world markets. In 2017, Byoung-Hyoun Hwang at Cornell and Hugh Hoikwang Kim at the University of South Carolina compared the market value versus net-asset value of closed-end investment funds (CEFs). They found that funds with annual reports burdened by just a one-standard-deviation drop in readability—a thicker veil of fog—exhibited a 2.5% reduction in market value.

“Our analysis,” wrote the professors, “suggests that a 10-percentage-point increase in the number of writing faults per sentence [based on SEC standards], on average, causes CEFs to trade at a 2.7-percentage-points greater discount.”

Hongkang Xu at the University of Massachusetts and colleagues at the University of Illinois and University of Toledo examined the relationship between companies’ ability to secure trade credit, or delayed payment terms, and the readability of their SEC form 10-Ks. Examining 4,754 firms from 2004–2016, Xu’s team found that suppliers with less readable 10-K’s normally get less credit.

A team led by Hatem Rijba at the Paris School of Business found in 2021 that less readable SEC form 10-K reports were associated with higher costs of equity. The equity cost was even higher when disclosures had a negative or ambiguous tone. The team looked at firms over the 1995 to 2017 period. Their data suggest that the mean added cost of equity capital for firms with high (poor) readability scores is 57 basis points.

Studies of this kind keep piling up. One suggests that when you write complex documents you raise the cost of debt capital by 77 basis points. Another finds that form 10-K complexity adds to the fees and length of audits. A third suggests that complexity reduces bid premiums for acquired firms during M&As. A fourth indicates companies incur a decrease in “cumulative abnormal returns” when they announce an alliance with firms with hard-to-read 10-Ks.

The cost of bad writing stems from the way the brain works. Science shows that if you don’t give the mind a stimulus that’s appealing — a piece of good writing in this case — it fails to respond with pleasing neurochemicals that motivate people to read further. If you do, you trigger a release of dopamine and other chemicals that hook readers — and keep them reading.

To be sure, scientists don’t know all the secrets of better motivating readers. Most research on fluency relies on correlation. Correlation between readability and financial gain can suggest a cause-effect relationship but doesn’t confirm it. The current crop of studies had an advantage in this respect. Three of them studied the year-over-year upgrading of disclosures as the SEC rule went into effect in 1998. This onetime event tended isolate readability as a factor, and the data for this period did suggest fluency causes financial gain.

Unfortunately, companies are ignoring the power of clear writing. Jeremiah Bentley at the University of Massachusetts and his colleagues reported that disclosures for the 2003 to 2019 period, based on Rule 421 standards, became more complicated.

If you want to improve your own disclosures’ readability, you can’t find a better guide to start with than the SEC handbook’s suggestions. The handbook’s tips are perennial aids to getting readers—and investors—motivated to consume your language. You can also heed other tactics that stem from what we’re rapidly learning about language processing in the brain. Here are a few I highlight in my upcoming book.

1. Fewer ads:

   Use strong verbs and nouns. Adverbs and adjectives often disrupt clarity, like coughing at the opera.

2. Break it down:

   Split up beefy thoughts and sentences. As a pro once said, “The period never comes soon enough.”

3. Cut caveats:

   Every argument has exceptions. Every topic demands context. Still, unless you’re specifically citing disclaimers, minimize the fig leaves of hedging.

4. Clean out residue:

   With each new draft, you’ll refine, reinforce, reiterate, and restate. Go back and strip out extraneous wording.

5. Keep it short:

   Don’t write more than your audience needs.

When you sit down next to write, keep one thought foremost in mind. It’s what we might call the Levitt principle: The simpler the words, the higher your pay.

Copyright 2022 Harvard Business School Publishing Corporation. Distributed by The New York Times Syndicate.

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