September 3, 2013

Laura Rittenhouse’s Candor Analytics

By Sally Helgesen – Originally published on

Warren Buffett’s annual shareholder letters are famous, a key element of his mystique. Inevitably, they’re described in the business media as “folksy.” But this description misses the reason these letters compel admiration from and influence the behavior of investors. The true strength of Buffett’s missives lies in their candor. (For example, here’s Buffett in the 2012 annual report of his firm Berkshire Hathaway, on his controversial investments in local newspapers: “Charlie and I believe that [some newspapers] will remain viable for a long time. We do not believe that success will come from cutting either the news content or frequency of publication. Indeed, skimpy news coverage will almost certainly lead to skimpy readership.”)

Plain-spoken candor is so rare in corporate communications that it’s not surprising it gets dismissed as eccentric, of a piece with Buffett’s continuing to live in the modest home he bought in the Omaha, Neb., suburb of Dundee in 1958. But candor is the currency that engenders trust, both among stakeholders and within a culture. And trust is precisely what Buffett has built over decades, in part by offering annual letters that avoid jargon and boilerplate.

In 1997, Laura Rittenhouse, a former Lehman Brothers corporate finance executive, had an aha! moment when reading one of Buffett’s shareholder letters. She had started an investor relations company after leaving Lehman in the early 1990s to help clients communicate more effectively with investors.

Buffett’s candor inspired her. Instead of trying to sell a strategy or blame external factors for a strategy gone wrong, he used plain English to share the essentials of what he was seeing, what he was thinking, and how his judgments informed his buys. On impulse, she wrote Buffett to tell him that his letters had expanded her understanding of candor and had given her a template for helping other companies be more forthright. Buffet wrote right back to tell her she was “doing the work of angels” and inviting her to his 1998 shareholder meeting.

Realizing she had to quantify candor in order to convince CEOs of its value, Rittenhouse set about developing a system of “candor analytics.” Adapting techniques used by forensic investigators and SEC analysts to determine whether someone is telling the truth, the system awards points for words, phrases, and linguistic patterns that indicate transparency. The system also deducts points for FOG, or “fact-deficient, obfuscating generalities”––clichés, jargon, incomplete explanations, euphemisms, platitudes, and contradictory statements. By 2000, Rittenhouse had compiled a 100-company list representing a range of industries and began offering the Rittenhouse Rankings, which grades CEO shareholder letters, teleconference scripts, and other forms of corporate communications.

FOG, Rittenhouse points out, can be either toxic or benign. Toxic FOG is used deliberately to disguise performance, strategy, or intent, with the lack of clarity serving to obscure results. Benign FOG results when lazy thinking shades into lazy speech. Rittenhouse notes an example of the latter that emerges with almost hilarious frequency in CEO shareholder letters of recent vintage: the constant recourse to a “climate of uncertainty” as an all-purpose explanation for timid responses, misguided decisions, or poor performance.

Rittenhouse correlates her candor scores with share performance. In 2012, for the seventh consecutive year, companies in the top quartile outperformed bottom-quartile companies, 32.4 percent to 17.1 percent. (You can find her 2012 rankings, also known as her “candor and corporate culture survey,” here.) Between June 2011 and June 2012, the average returns of top-ranked companies increased 9.9 percent, while low-ranked companies experienced a 5.7 percent decline. Top-ranked candor companies included Costco, Southwest Airlines, Travelers, Ford Motor, and Home Depot, whereas the companies that ranked highest in obfuscation were Cigna, Humana, Hewlett-Packard, and Bank of America.

Rittenhouse’s method comes under fire (for example, in some comments on the Amazon page for her book, Investing between the Lines: How to Make Smarter Decisions by Decoding CEO Communications [McGraw-Hill, 2012]) by those who believe it lacks rigor or is not quantified enough. “Investors say to me, ‘Why not just look at the numbers? Numbers are precise, whereas words are not,’” Rittenhouse says. She counters that words always inform the numbers. “Numbers are only as accurate as a company’s accounting, and accounting reflects judgment. For example, a company will decide to count this metric but not that one, and that decision will determine how the numbers come out––we got a close look at how this works in 2008. A company can be aggressive in how it interprets the numbers––Enron is the classic example. Or it can be conservative, like Berkshire Hathaway. In either case, it behooves investors to take a look at the quality of the conversation in the organization. That will tell them if the judgments that inform the numbers should be trusted.”

Numbers are notoriously poor instruments for describing culture, so Rittenhouse’s insights about the power of candid speaking seem especially relevant for organizations undergoing or trying to implement culture change. Culture is embedded in words, and being aware of the quality and accuracy of the words top leadership uses is essential in reshaping a culture or making it more congruent with the company’s mission. As Rittenhouse notes, analyzing the conversation in a company is the best way to understand its culture and assess its capacity to inspire trust––among investors, the public, customers, clients, and employees. Because culture change always challenges trust, using boilerplate or jargon to try to effect it will inevitably undermine the effort. Candid language offers a better path.