Readability of Management's Discussion and Analysis

A management discussion and analysis (MD&A), as required by the Securities & Exchange Commission (SEC), discusses issues and trends relating to a firm's liquidity, capital resources, and operating results. The SEC has repeatedly expressed concern that this discussion be understandable to investors. A study was undertaken to analyze the readability of MD&As, using firms selected from the 1986 Fortune 500 and the 1986 Fortune Service 500. The study examined 3 aspects of writing known to affect readability: 1. the use of the passive voice, 2. word length, and 3. sentence length. The Flesch Index was used to estimate the education level needed to comfortably comprehend each narrative with a single reading. The results of the study indicate that the MD&A can be made more readable and comprehensible to users. Although the MD&A and the president's letter both allow significant flexibility in style and presentation, the MD&A's understandability indicators resemble those of the footnotes more often than those of the president's letter.