On the Informational Effectiveness of the Compensation Discussion and Analysis (CD&A): Evidence From Textual Features

Abstract

Since the SEC’s 2006 mandate for the Compensation Discussion and Analysis (CD&A), its disclosure has increased significantly. Shareholders complain that CD&As are difficult to read and lack useful information. Despite uniform SEC guidelines, firms vary significantly in how they construct and organize CD&As. Motivated by these concerns, we investigate the relation between CD&A textual features and their effectiveness in fulfilling the SEC’s objective: providing material information to assist shareholders in evaluating executive pay. Using over 12,000 CD&As from large U.S. firms, we construct textual variables that capture the information processing costs of CD&As, including length, reader friendliness, and linguistic readability. We find that information asymmetry increases and shareholder support for executive pay decreases after firms file harder-to-process CD&As, primarily due to length and lack of reader friendliness. Supporting an agency-based explanation, these CD&As are associated with higher total and excess CEO pay, as well as weaker firm performance. By decomposing CD&A textual processing costs into compliance and residual components, we show that residual components drive undesired disclosure outcomes. Our findings highlight the importance of understanding the textual processing costs of disclosures and how these costs relate to disclosure effectiveness.