Researchers Study CEOs' Annual Shareholders' Letters for Tone

A press release from University of Nebraska:

Study unlocks language of CEOs; provides 'heads-up' for auditors

Honesty, attitude and behavior of CEOs, sometimes referred to as “tone-at-the-top,” mean a lot to analysts and shareholders of any company, especially as firms try to protect their reputations during an economic downturn.

One tool CEOs use to manage confidence in their firms is their annual letter to shareholders, something a pair of University of Nebraska-Lincoln researchers have looked at closely in recent months. What they found can potentially predict which companies are likely to make it through difficult financial times with their reputation intact – and which ones may merit a closer look from regulators, analysts and auditors.

The study, by UNL College of Business Administration professors John Geppert and Janice Lawrence, used content analysis software on dozens of the yearly letters from CEOs to their shareholders. The computer analysis’ discovery: Chairmen at high-reputation firms have a distinct language style, using shorter words and clear language. Meanwhile, CEOs at less reputable firms use more complex phrases, buzzwords and a more muddled writing style.

“These differences in word choice in the CEOs’ letters to shareholders are not readily apparent to the naked eye, but the computer program picked up on these subtle differences. The results find the words used at companies with ethical reputations are short and to the point – fewer adjectives – and the words that are used are more concrete. That means these words have one understood meaning,” Lawrence said.

“Firms with less ethical reputations use longer words and more adjectives and the words they choose are less concrete – words with multiple meanings. Perhaps these words could be characterized as ‘weasel’ words.”

For example, a passage from a high-reputation firm’s chairman, written to shareholders in 2002, read like this: “As a leading provider of low-cost mortgage capital for home buyers to finance their homes, our firm is at the center of the housing industry, one of the strongest growth sectors in America.” Meanwhile, a CEO at a less reputable firm said: “…we remain committed to being good stewards of our asset base and to taking action regarding underperforming assets wherever possible.”
 
Geppert and Lawrence’s study, which appeared in a recent issue of Corporate Reputation Review, could help regulators and auditors evaluate CEO shareholder letters for clues as to which companies merit further investigation. Lawrence said that fraud happens when the opportunity, motivation and ability to rationalize the occurrence of fraud come together.

CEOs always have, by the nature of their position, the opportunity and the motivation to commit fraud, but the hard part to determine is the ability to rationalize fraud - the mindset of the head of the company.  

“It is hard to gather evidence about the CEO mindset, yet tone-at-the top is critical to company ethical behavior and firm reputation,” Lawrence said. “Our research could be called a ‘heads-up’ to the auditors and regulators such as the SEC.”

The study suggests that in a time when corporate earnings are down, chairmen may be more inclined to craft letters designed to influence more than inform.
 
“The choice of words matters; it reflects subtle beliefs, motives and intentions that are difficult to hide,” said Geppert. “Investors are wise to scrutinize the Chairman’s letter for unnecessary qualifiers and ‘filler’ language.”  

Geppert is an associate professor of finance. His research focuses on investments, time series analysis and international finance. Lawrence is Director of the Business Ethics Program and is an associate professor of accountancy. Her research interests include fraud, auditor skepticism and business ethics.

For more information:

John Geppert, associate professor, finance, (402) 472-3370, [email protected]
Janice Lawrence, associate professor, accountancy, (402) 472-5152, [email protected]

(Thanks to Steve Smith at UNebraska)