It is well established that words matter. Yet, we have little knowledge on how language is utilized to frame and how that framing influences investors. Do different types of language affect the perception of risk? Can risk be made to appear more or less acceptable to investors?

We investigated these questions in our Journal of Management Studies article by examining rhetoric as described by Aristotle – Logos (argumentation based on logic, methodological rationale of facts, figures, and calculations), Pathos (argumentation based on happiness, sadness, fear, surprise, anger, and disgust), and Ethos (argumentation based on overall character, credibility, virtuousness, ethics, and other normative appeals). Using a mediation model, we find that all three rhetorical forms affect the perception of risk, influencing investor decisions.

How investment risk, investment performance, logos, pathos, and ethos rhetoric interact

We suspected that authors of investment narratives can and do adjust their rhetoric to justify or minimize perceived investment risk because of the inextricable linkage between risk and return.

Generally, we argue that authors of investment narratives (IPO prospectuses in this case) representing firms with inconsistent financial performance information—indicating more investment risk—will use relatively more logos compared to pathos and ethos rhetoric. The information asymmetry of the inconsistent performance is a perceived weakness, which can be better elucidated by using a relatively more methodological (logos) argument that could explain the inconsistency and what can be done to improve it.

In contrast, investment authors representing firms with a history of consistent financial performance—indicating lower investment risk—will use relatively more pathos and ethos compared to logos. Investment authors likely view the consistent performance as a potential weakness for those investors attracted to high growth potential. Pathos can be used to pull at the emotions of investors—i.e., excitement, anticipation, greed, fear—to persuade investors that the firm has certain attributes or opportunities that could promote high growth and profits. Ethos then substantiates the pull of those emotions as authentic and trustworthy.

However, the issue that investment authors may not be fully considering when formulating the narratives are the limited cognitive abilities of both authors and investors. Narrative authors have a finite number of words, limited attention spans, and restrictions on mental capacity. Similarly, investors do not have the desire, attention spans, or mental capacity to sift through vast amounts of information. Therefore, authors must optimize the words they use in investment narratives. Following this line of thinking, it seems that some investment authors inadvertently hurt the firm’s investment performance by the rhetoric they used. Our findings suggest that the most optimal wording consisted of more pathos and ethos and less logos. We suspect this is because the data, which are inherently logical and methodological, found in investment narratives are also communicative symbols that can, at least partially, replace the logos argumentation. Therefore, the most persuasive arguments in investment narratives allow the financial data to partially fill the logical role while pathos and ethos fill the emotional and character roles; this type of arrangement seems to form the most complete and effective argument.

We analyze two examples below using the following key: Logos, Pathos, Ethos:

Excerpt from Dunkin’ Brands IPO Prospectus Example 1:

For example, we reduced the upfront capital expenditure costs to open an end-cap restaurant with a drive-thru by approximately 23% between fiscal 2008 and fiscal 2010. Additionally, between fiscal 2008 and the first quarter of fiscal 2011, we believe we have facilitated approximately $220 million in franchisee cost reductions primarily through strategic sourcing, as well as through other initiatives, such as rationalizing the number of product offerings to reduce waste and reducing costs on branded packaging by reducing the color mix in graphics. We believe that the majority of these cost savings represent sustainable improvements to our franchisees supply costs, with the remainder dependent upon the outcome of future supply contract re-negotiations, which typically occur every two to four years.

Our Analysis:

Here, Dunkin’ Brands is addressing the challenge of lowering per store costs. This is an example of overemphasizing logos while ignoring pathos and ethos. Arguing that they reduced the upfront capital expenditure costs by 23% and have facilitated $220 million in cost reductions should be enough logos for this specific argument. Following up with more logos framing, such as reducing waste and reducing costs on packaging is repetitive and adds little argumentative value. Instead, follow up with how these cost reductions not only save financial resources, but also help Dunkin’ carry out their mission of being socially aware to reduce waste for the human race and that customer response has been enthusiastic. Our suggested approach would create persuasive arguments with all three framings, not just one framing.

Excerpt from Dunkin’ Brands IPO Prospectus Example 2:

In the U.S., Baskin-Robbins core strengths are its national brand recognition, 65 years of heritage and #1 position in the QSR industry for servings of hard serve ice cream. While the Baskin-Robbins U.S. segment has experienced decreasing comparable store sales in each of the last three years due primarily to increased competition and decreased consumer spending in each year, and the number of Baskin-Robbins U.S. stores has decreased since 2008, we believe that we can capitalize on the brands strengths and generate renewed excitement for the brand, including through our recently introduced More Flavors, More FunTM marketing campaign.

Our Analysis:

In this segment, they are addressing the challenge of increasing comparable store sales. This segment counters the previous example above by demonstrating how Dunkin’ Brands using more pathos and ethos creates a more well-rounded and persuasive argument. Instead of overusing logos framing, they let the data – 65 years of heritage and #1 position in the QSR industry – speak for itself, filling part of the logos framing. This provides the opportunity to use all three framings to improve the argument, adding that the strengths, recognition, and excitement of their brand will help address the challenge.

Through these examples we have given a brief display of how authors of investment narratives can build more persuasive arguments by building more complete arguments that effectively utilize argument utility of rhetoric and other communicative symbols.