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13 December 2018 CFA Institute Journal Review

Linguistic Complexity in Firm Disclosures: Obfuscation or Information? (Digest summary)

  1. Thomas M. Arnold, CFA
The linguistic complexity of quarterly earnings conference calls is measured to determine the degree of information revelation and information obfuscation. A novel approach disentangles the key components of linguistic complexity. Median values indicate as much as a 12% decline in liquidity because of the obfuscation component.

How Is This Research Useful to Practitioners?

Quarterly earnings conference calls offer an opportunity for prepared disclosure by management (i.e., the presentation) followed by unscripted discussion by management and analysts (i.e., the response).  The former is generally more linguistically complex than the latter.

Based on prior literature and such incentives as management’s hiding damaging information, more linguistic complexity is associated with less informative disclosure, which results in more informational asymmetry between management and investors. Linguistic complexity can also be associated with business complexity.

The authors are able to distinguish business complexity from linguistic complexity. With the response portion of the conference call, informative disclosure and information obfuscation can be identified within linguistic complexity.

Consequently, the linguistic complexity of an earnings conference call may allow practitioners to better determine what disclosure is informative. Interestingly, the linguistic complexity in the conference calls of poorly performing firms is generally not wholly obfuscation but instead part obfuscation and part informative disclosure.

How Did the Authors Conduct This Research?

The authors examine 60,172 quarterly earnings conference calls between 2002 and 2011. The linguistic complexity of each conference call is measured by the Gunning fog index and the link to information asymmetry is measured using the Amihud (Journal of Financial Markets 2002) illiquidity construct. Separate index measurements are taken for the presentation and response portions of the conference call.

The response portion of the conference call is considered to be more informative because analysts have little incentive to obfuscate information; it is also empirically found to be less linguistically complex. Designating analysts’ linguistic complexity as the benchmark for managers’ appropriate disclosure in the absence of obfuscation is the key measure that enables the authors’ analysis and conclusions.

Using this information as well as control variables for business complexity, the authors separate linguistic complexity into a portion that is informative and a portion that creates more informational asymmetry between management and investors (i.e., obfuscation). It is through this separation that the authors discover that a previously documented overall positive relationship between linguistic complexity and information asymmetry becomes bifurcated to negative for information and positive for obfuscation.

Abstractor’s Viewpoint

I found the authors’ empirical design and findings—in particular, that earnings conference calls are a combination of obfuscation and of informative disclosure—interesting. I am not certain that the conclusions are completely surprising to the practitioner, but the ability to demonstrate this empirically could lead to more important findings in the future.

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