A research paper published in the Journal of Business Ethics finds that companies that use “trust words,” such as “character,” “ethics,” and “honest,” in the MD&A section of their SEC Form 10-K “have lower information content” in their earnings announcements than firms that do not use trust words. In Can We Trust the Trust Words in 10‑Ks?, Myojung Cho (Lubin School of Business, Pace University), Gopal V. Krishnan (Department of Accountancy, Bentley University), and Hyunkwon Cho (SKK Business School, Sungkyunkwan University) also find that “firms using trust words are more likely to receive a comment letter from the SEC, pay higher audit fees, and have lower corporate social responsibility scores.” In short, the use of trust words in the 10-K is “associated with negative outcomes, and trust words are an inverse measure of trust.”
The authors counted the number of times 21 trust words appeared in the MD&A section of 3,595 reporting company Form 10-Ks from 1995 to 2018. The 21 words were: accountability, character, ethics, ethical, ethically, fairness, honest, honesty, integrity, respect, respected, respectful, responsible, responsibility, responsibilities, transparency, trust, trusted, truth, virtue, and virtues. About half of the sample used the trust words and the mean value of the number of trust words used was 1.8.
Study findings include:
Market reaction to earnings announcements is lower for companies using trust words than for those that do not. This suggests “that the use of trust words is negatively associated with the information content of earnings.”
“Lower ability managers” are more likely to use trust words.
Companies that use trust words are more likely to receive comment letters from the SEC, and these comment letters are likely to raise accounting issues.
Companies using trust words tend to pay higher audit fees. “Our result suggests that auditors assess higher audit risk or/and exert greater audit effort for firms using trust words in 10-Ks., suggesting higher audit risk for these firms.”
There is a negative relation between the use of trust words and corporate social responsibility scores.
The overall conclusion of the paper is that “firms using trust words tend to invite more scrutiny from investors, the SEC, auditors, and others. Thus, the use of trust words seems to reflect the opposite of a firm’s culture of trust * * *.”
Based on their findings, the authors offer advice to investors, corporate management, and regulators:
“Our results suggest that investors need to be mindful of firms using trust words and not fall prey to such unscrupulous behavior. To managers, our results indicate that impression management via trust words may do more harm than good. Thus, managers need to reconsider using trust words unless they plan to honor the sentiment. Finally, the SEC and the PCAOB could use trust word disclosures to flag registrants for further examination.”
The overuse of trust words may be a symptom of underlying weaknesses in corporate culture. In reviewing MD&A and other company disclosures, audit committees may want to be alert to these words and consider whether they describe tangible corporate policies or are simply an attempt to create a favorable impression untethered to reality.
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