'Plain English' and Say on Pay: Regulatory Requirements vs Potential Behavioural Consequences
Since 2011, listed US companies are required to hold an advisory shareholder vote on the remuneration of named executive officers on information provided in the Compensation Discussion and Analysis report (CD&A) While the SEC requires that the CD&A be written in 'Plain English' commentators relay general dissatisfaction among the investment community regarding the readability of the average CD&A (Larcker et al. 2015) Prima facie, this calls for firms to invest in improving disclosure in the CD&A. The probable consequences from this investment however, in terms of affecting the outcome of the say on pay vote, are far from clear. Ample evidence exists in the Psychology, Finance, and Accounting literatures which suggests that readability can affect decision making within a financial setting. Lawrence (2013) finds that individual (small) investors are attracted towards investments in firms with clearer and more concise financial disclosures and argues that readability brings informational advantages for individual investors. The readability of financial disclosures may also affect the way that investors make decisions. Research from the Behavioural paradigm document a number of observed heuristics which may guide individuals' decision making. Rennekamp (2012) argues that readability evokes the processing fluency heuristic, whereby information is perceived to be more credible if it is provided in a more readable manner. There is a danger that if shareholders are too quick to endorse pay decisions on the basis of inflated credibility, then a culture of excessive pay may prevail relatively unchallenged. We demonstrate that CD&A readability, inversely measured using the Gunning Fog Index, has the effect of weakening the link between an established proxy of CEO excess pay and the probability of receiving a low say on pay voting result (firms with more readable CD&A are less likely to receive a no vote, despite similar levels of estimated CEO excess pay) This suggests that increased readability does on average lead to shareholders placing a greater decision weight on arguments presented in the CD&A framed in favour of proposed pay. While Rennekamp (2012) demonstrates that readability of press releases affects valuations using an experimental approach we examine the impact of processing fluency in a real setting where inflated credibility of management may significantly affect the voting outcome.