Pragmatics, Implicature and The Efficiency of Elevated Disclosure
Pragmatics, Implicature and The Efficiency of Elevated Disclosure, an article now posted on SSRN that sprang from my thoughts about the FASB’s Disclosure Framework Project, which I discussed in my presentation on the Theories of Disclosure panel at the 2011 AAA Meetings in Denver.
Here is the abstract:
This paper uses a Pragmatic theory of language (drawn from philosophy and linguistics) to diagnose the causes of excessive and inefficient financial disclosure and propose a regulatory solution. The diagnosis is that existing regulations are effective at encouraging firms to adhere to some, but not all, of the Maxims of Conversation identified by Pragmatics. Regulations encourage firms to disclose any information that might be relevant, but are ineffective in discouraging excessive disclosure of information that is of little relevance given what investors already know. This one-sidedness makes financial disclosures inefficient by limiting the ability for investors to infer that items the firm chooses not to disclose are not particularly important (an inference Pragmatic theorists call “implicature”). The solution is to encourage or require firms to supplement comprehensive disclosures with an “elevated” disclosure that is brief enough to force firms to be selective in choosing what information to include. Regulations can enhance implicature through rules that prohibit firms from elevating disclosures that are less newsworthy than disclosures that are not elevated, thereby enhancing the information conveyed to investors through implicature.
Philosophers are keen on distinctions, and the first part of the paper is largely devoted to describing the most important ones to accountants. One key distinction is between speech and the speech act: speech is the content of what we say, while the speech act is the choice to say it. This becomes important because (as game theorists in disclosure know well) the choice to say something or not say something conveys information on its own. A second distinction is between implicature–the information content conveyed by the choice of speech act–and explicature, which is the content of the speech itself, and all that it logically entails. One of the main points of the article is that mandated comprehensive disclosure limits speech acts by forcing firms to say everything. This is an extremely inefficient form of disclosure, because speech acts are the foundation of implicature, which is a wonderful source of efficiency: it allows investors to draw inferences from what is not disclosed. What could be more efficient than that?
The bottom line of the paper is a set of three disclosure regulations to increase the implicature in an “elevated” disclosure that would supplement the comprehensive disclosure firms already provide:
1. Firms must elevate material deviations from prior understanding.
2. Firms must not elevate so many deviations as to eliminate the advantages of elevation.
3. Firms must not elevate deviations from prior understanding that are less material than a deviation that is not elevated.
The first rule mandates that the firm flag some content as particularly newsworthy, while the second prohibits firms from elevating everything (which is the same as elevating nothing). The third rule is the key to implicature: firms can’t elevate one thing without elevating everything else at least as newsworthy. As a result, investors can infer that a firm that chooses not to elevate information about X believes that X is not as newsworthy as the least-newsworthy information that is elevated.
Two final comments. First, “newsworthy” refers to the deviation of the information from what readers would expect given what they already know. For example, revenue recognition policies that are typical for the industry are important, but not newsworthy. It’s interesting to note that the current definitions of materiality don’t focus on newsworthiness, but just whether an investor who knows nothing would find the material relevant. This is one reason corporate disclosure is so inefficient.
Second, most people who comment on the paper raise questions about how such a regulation could be implemented. I don’t address that in the paper, but I don’t see that this type of regulation would be much more difficult to implement than many disclosure regulations already on the books. That doesn’t make it easy, of course, but such concerns are no reason to dismiss the idea out of hand.]]>