“If a Company Says It’s Ethical, Investors Might Want to Be Skeptical” - Lisa Ward

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Article Summary

This article highlights the use of “trustworthy” language by companies on their financial reports and the opposing reality of consumer and analyst statistics. When making annual reports, around 40% of companies were found to use language associated with building a trustworthy relationship between the companies and the general consumer base. These words, which typically signify transparency and good results, were found to incorrectly reflect the overall financial performance of these companies. 

At the end of each fiscal quarter, companies release financial reports detailing expenditures, revenues, available cash flows, and overall profits or debts. These reports are meant to provide concrete, factual information about the company and its performance. Experts, analysts, and the general public refer to these publishings to make predictions on future company performance and also use them to justify investment decisions. 

Misleading reports like the ones discussed in the article would seemingly cause a company’s stock price to increase artificially. However, a study by M. Cho, Krishnan, and H. Cho (1) shows that companies using words implying consumer-company trustworthiness like “ethics” and “honest” had negative correlations with business performance in different measures. Some examples include a smaller increase in stock value of companies using the subset of words examined compared to those who did not. Also, these companies paid more for auditing of their files and were more likely to be asked to clarify parts of their report because of vagueness or misinterpretation. (3) The author also was keen to note that the study and its findings do not necessarily imply that trustworthy words caused distrust among consumers and negative stock performance; only a correlation was identified.

Personal Discussion

From my perspective, there are more unreviewed factors that could be influencing the relationship between consumer perception and company performance. Some include the potential masking of poor performance by the company and external influences like other, unofficial public releases. 

When companies have positive performance and the data of their report reflect this, there is no reason to include persuasive language in their report, and thus consumers clearly see the performance. As a result, the stock price and value of the company increase. On the other hand, a report with a negative trend would lead to a decrease in the company’s stock price. Companies know this, and to protect their value, they try to mask the true performance of the company with trustworthy language. The small increase that was seen in the study (1) may be a result of this language fooling consumers rather than skepticism. 

Another possibility of a different causation is the release of public statements by the company and its executives at the same time of the release of the report. A large percentage of the consumer base, especially leisure investors and young people, use analysts’ videos and reports as well as the statements of the company’s executives to determine the performance of a company instead of consulting the data. These reference points are not subject to the same restriction and auditing, and as a result they often mislead consumers with false or exaggerated claims. This would also explain the stagnant performance of these companies as opposed to decline. 

It should be noted that trust in companies by consumers should be skeptical at best. Blind trust in the financial sector has been the cause of pyramid schemes, fraud, and trust scams as described in Personal Finance (2). These findings support the article’s claim that people are not finding “trustworthy” language as trustworthy since there has been a shift towards security and reliability of information in the financial sector over the last decade.

Financial literacy of the general public should also be considered since financial reports require sufficient literacy to understand. In a 2008 study by Lusardi, specific survey questions that were used to measure the financial literacy of groups in the public found that around half of elderly citizens were unable to answer basic financial questions, with higher numbers among high school students and young people. (4)

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Sources

1. Cho, Myojung, et al. “Can We Trust the Trust Words in 10-Ks?” SpringerLink, Springer Netherlands, 23 Feb. 2023, link.springer.com/article/10.1007/s10551-023-05350-y.

   
   

2. Personal Finance. Lumen Learning, LibreTexts. 2024

   
   

3. Ward, Lisa. “Beware When a Company Says It Is Trustworthy.” The Wall Street Journal, Dow Jones & Company, 23 June 2024, www.wsj.com/finance/investing/ethics-companies-trust-b182f2b5.

   
   

4. Lusardi, Annamaria. Financial Literacy: An Essential Tool for Informed Consumer Choice?. June 2008