Russia Crushes the U.S. in Corporate Disclosure Qualityby
China’s biggest e-commerce player, Alibaba, is expected to file for its initial public offeringin the next few days. Even though the company is expected to list its shares on the New York Stock Exchange, a lot of American investors may opt to stay on the sidelines, simply because Alibaba is a non-U.S. company. That would be an example of a well-known concept called home bias, which is a nice way of saying American investors have a tendency to be xenophobic about overseas stocks.
Companies in other countries know this—and go out of their way to write clearer financial disclosures—as a way to encourage otherwise-skeptical American investors to buy shares in their businesses. Russell Lundholm, a professor of accounting at University of British Columbia’s Sauder School of Business, sets out to quantify this trend in a soon-to-be published paper.
Lundholm’s analyzed the SEC filings of non-U.S. companies listed on U.S. stock exchanges and compared the writing clarity with that of filings by American companies. He quantified two factors: the clarity of the words themselves and the number of specific numerical details.
To analyze the text, he uses a readability formula that converts the writing into a number representing how many years of school somebody would need to understand it. In this case, a smaller number (such as 15) defines a more accessible document the public can better understand. Larger numbers (such as 18) suggest harder-to-read texts, filled with long sentences and complicated words.
Lundholm also analyzes how often specific numbers were used in the filings. Companies that want to be crystal clear about their business operations will give exact numbers, rather than cloud them in wordy, numberless descriptions.
“We assume the U.S. is better at these things,” Lundholm says, “so it’s surprising that foreigners beat the American firms.” Lundholm’s analysis clearly points out another phenomenon: It’s not just that foreign companies do better than their American counterparts, but also, the farther “you get from the U.S. on any dimension, the clearer the communication is.”
There are a lot of ways to measure “farther away” from the U.S. The simplest is the actual geographic distance. Other approaches include differences in accounting rules or differences in native language. Canada has hard-to-read disclosures with few numbers. It’s not as good as in the U.K., where companies received high marks for easier-to-read disclosures and much more specific numerical data in their releases.
A sampling of countries with some of the clearest communications makes for a surprising list: Indonesia, Argentina, Venezuela, Greece, Spain, Portugal, and Russia.
Frank Luntz, who runs the language and messaging company Luntz Global, offers a reason for this difference. “American companies often act defensively out of a fear that whatever they say will somehow be used against them.” Luntz also says “It’s hard to blame them,” because “companies and organizations that admit mistakes are often criticized for poor management or holding back information rather than praised for their candor.” As a result, there “is a desire to say less at a time when shareholders want to know even more.”
Richard Truesdell, co-head of Global Capital Markets at the law firm Davis Polk & Wardwell, agrees with the conclusions but isn’t so sure about the home bias. “Most companies, when they list in the U.S., involve outside counsel and investment banks to help the company write disclosures,” Truesdell says. “The foreign companies are advised on what type of information the market needs and what their peers are doing.” He also agrees with the notion that foreign companies that use International Financial Reporting Standards (IFRS) accounting standards instead of the Generally Accepted Accounting Principles (GAAP) usually used in the U.S. do need to provide further details “to make it more comfortable for investors.”
MIT Sloan professor Andrew Lo says non-U.S. companies “have no choice but to engage the services of corporate communications experts.” They “have to spend additional dollars to hire people to make these type[s] of translations,” while U.S. companies can often engage their internal staff to write the documents. Lo also says that “numbers are the universal language” and that non-U.S. businesses “might be more comfortable providing numerical details rather than narrative, which is a more complex and nuanced form of communication.”
Lundholm says “it’s a conscious decision” for these foreign companies. They’ve chosen to list a stock in the U.S., and they know they face a home bias against them. As a result, they go out of their way to overcome that perception problem. They do it through clear filings and communications.
Does any of this matter? According to Lundholm, the answer is yes, because foreign companies with the clearest disclosures also achieve greater success among U.S. investors.