July 24, 2024

Advancing Corporate Yields

Pioneering Business Success

Deeds Speak Louder Than Words When Communicating Corporate Ethical Commitment

When it comes to the company’s commitment to “trustworthiness”, business leaders should concentrate more on the substance of their commitment, rather than on how that commitment is described to investors, regulators and the public.

That’s the main leadership takeaway from a fascinating new academic study analyzing the impact of the use of certain trust words, such as “character,” “ethics,” and “honest,” in the MD&A section of the SEC’s Form 10-K for annual reporting. The study was recently analyzed in The Wall Street Journal.

The study was based on a computer survey of the use of 21 “trust words” in the annual 10-K filings of over 3500 companies between 1995 and 2018. Forty-five percent of the firms surveyed used trust words in their filings (while 55% did not). The study drew three primary conclusions:

As to Earnings Announcements:

The study found that the use of trust words in annual statements correlated with a decreased interest in the stock of the company in question. Specifically, in the first 48 hours after earnings announcements, stock prices increased on average about 1.15% for companies that didn’t use trust words in their reporting. This, compared with stock prices of companies that did use trust words, that increased only about 0.11% in that two-day period.

As to Regulator Interest:

Further, companies using trust words were approximately 15% more likely to receive a comment letter from the SEC asking for clarification on their 10-K filing, than companies that did not use trust words. As the Journal article noted, such requests can sometimes reflect specific SEC concerns with the annual report.

As to Auditor Fees:

The study also concluded that companies using trust words in their 10-K filings were more likely to incur higher auditing fees (e.g., $100,000 or more) than those companies that do not use such words in their filings. As the Journal article noted, academic researchers frequently track auditing fees in order to interpret corporate risk (i.e., the possibility that higher auditing fees might suggest greater risk).

Thus, the overarching conclusions of the study are that there’s a correlation between the use of trust words in corporate Form 10-K filings and negative outcomes, and that “trust words are an inverse message of trust”.

Corporate leaders wouldn’t be cynical if they were to “poke holes” in the study’s credibility; e.g., “it’s outdated”; the conclusions are based on coincidence rather than hard data; this is just academics playing with numbers. To that theme, it should be noted that the study didn’t evaluate whether there was any causal link between the use of trust words, and the actual loss of trust by investors or others. Rather, the conclusion was simply that there is a statistical correlation between use of trust words and negative outcomes.

Yet that conclusion alone might well be enough to attract the attention of executive and board leaders; i.e., that in a business world where statistical controls make a difference, data on the use of trust words may at the least suggest a bit of risk-related smoke, if not fire. That less bravado and more modesty might be appropriate for corporate communications intended to convey organizational ethics. That when it comes to demonstrating corporate trustworthiness, there may be value in letting “deeds” speak for themselves.

Indeed, the study unintentionally brings to mind the ongoing merit of the old phrase, “Tone at the Top,” when it comes to ethics and responsibility. It’s a core principle of corporate responsibility: the most enduring messages of ethics, honesty and trustworthiness are those created by the conduct of corporate leaders.

And it’s a form of messaging that carries weight with corporate regulators. Over the years and across agencies, they’ve sent a consistent message. When it comes to establishing a company’s ethical bona fides, the bottom line is always whether the company can “walk the walk”, not just “talk the talk” (in corporate filings or other communications). “Actions will be far more significant than words.”

And when it comes to matters of corporate ethics, honesty, integrity and trustworthiness, “Tone at the Top” should be carried forward through every organizational echelon. To paraphrase a former senior Department of Justice official, ‘If trustworthiness is not the real culture, then it’s useless no matter how well it is written on a piece of paper’.

Business leaders may fairly debate the methodology of this new survey, but they would be wise not to miss its underlying message. With apologies to organizational communications experts, the generous use of “trust words” in corporate reporting can have a boomerang effect if they’re not believable to the broader workforce.

The new survey provides an inexpensive reminder to corporate leadership of that truism.

I’d like to thank my partner Ashley Hoff for her always-helpful contributions to this post.