Unpacking the Graphic Content of Annual Reports

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Lei Gao and Bo Hu
Lei Gao and Bo Hu

Viewed one way, the corporate annual report is redundant, merely repeating information in publicly available 10-K filings, as well as on Bloomberg, Yahoo! Finance, etc. Still, most companies that issue stock publish annual reports for the general public, despite the SEC not requiring them to do so.

Part of the reason may be that with the annual report, companies are in complete control of the presentation. They can use graphic elements to capture and direct investor attention. Visuals can also convey suggestive messages that, though non-explicit, can exert subtle influence. Color choices, for example, carry emotional associations that can transfer over to the firm; pleasant or exciting illustrations can affect how readers interpret information. These graphic effects can help managers hint at hidden strengths or intangible assets not yet reflected in the firm’s financials.

According to a recent working paper co-authored by Mason finance professors Lei Gao and Bo Hu, more than 80 percent of U.S. public firms use graphics in their annual reports. Further, visual presentation has market benefits as well as aesthetic ones.

Lei and Bo, and their co-authors Wesley Deng of University of New South Wales and Guofu Zhou of Washington University in St. Louis, analyzed the annual reports of 1,322 companies from 1994-2019 alongside their financial performance. They focused particularly on reports that, from one year to the next, exhibited a sudden increase in “graphicity”—a construct invented by the researchers to measure the ratio of visual to verbal information contained in a report. Graphicity was calculated with the help of a machine learning algorithm capable of detecting, among other things, the relative size, color, and number of graphic elements in a document.

The researchers discovered that firms that went in a more graphical direction  received an average abnormal return of 3.5 percent over the three-to-six-month period following the release of their report. The bump in stock returns could not be explained through other characteristics such as institutional ownership, analyst coverage and short selling constraints.

The three-to-six-month delay represents the time it takes for the subtle information in graphic reports to permeate the market. “Numbers can be picked up in no time by algorithms and factored into the stock price,” Lei said. “But graphic information takes time to consume, it’s harder to pick up this kind of information.”

The researchers also looked at the firms’ business activities to determine whether going graphic could be construed as signaling an intention. They found a pattern of increased R&D investment in the three years following a pivot to visual communications in the annual report.

“An optimistic take on this correlation would be that firms are using visuals to telegraph their soon-to-be-realized potential to investors,” Bo said. In other words, graphicity could function as a kind of “Watch out, here I come” announcement to the market. Visual cues can also give a non-specific sense of what’s being planned in terms of innovation and tech adoption. For example, a manufacturing firm can display its aspirations through an image of a futuristic factory.

On the other hand, graphicity can sometimes be misleading. “Not every R&D initiative will be value-adding,” Lei reminds us. Firms could be using images to paint a risky investment with a rosier tint. “These firms are doing something serious, but it’s hard to deliver. They might face more uncertainty. So, they use soft information to make claims, because if you put in hard numbers you’re liable for the risks.”

Lei and Bo say that theirs is the first paper to quantify the market impact of the tacit messaging conveyed by the graphic design of annual reports. Their findings imply that regulators should perhaps pay attention, since the visual content of corporate documents are absorbed by investors as information, not decoration. Moreover, the signals embedded within visual cues are not wholly ambiguous but consistently predictive of future firm activity, i.e. R&D investment. You could say that high-graphicity reports are communicating with investors on two dimensions at once— visual and verbal—while regulators now are probably concerned only with the latter.

If the government were to monitor the graphic content of annual reports, Lei and Bo’s methodology gives some clues about how it might be done fairly and with minimal human labor. Primed with a construct such as graphicity, an algorithm could crawl through annual reports (usually found within the “Investor Relations” section of a corporate website) and trigger an alert whenever it spotted abrupt and sizeable shifts—50 percent was the threshold the researchers used—from verbal to visual presentation.

Consistent with our model, this work provides evidence of a new anomaly in financial markets,” Bo said. “If it is not recognized, it must be novel and needs more attention from market participants.”