Flickr / Georgie Pauwels.

While company 10-K reports are known for being somewhat difficult to get through, there isn't a whole lot of research into the question of why. 

A recent National Bureau of Economic Research paper finds there is evidence of "strategic opacity" across industries, meaning certain sectors might be prone to unspoken cooperation when it comes to disclosing unflattering industry news. 

Thus, understanding how to read between the lines of a 10-K could give you more insight into a particular industry, as well as the possible downturns that might be ahead. 

It's all about readability 
Because there isn't a lot of wiggle room in what a company can disclose on a 10-K, the major tool that companies have available is the way in which they disclose data.

The annual 10-K reports are seldom a picnic to read, but their level of difficulty tends to vary widely. The researchers found that, every once in a while, industrywide complexity in 10-Ks suddenly increases -- meaning, essentially, that everyone's reports become more complicated at the same time. This tends to predict more negative returns later on.

The more difficult it is to parse the story, the more likely it is that the story is covering something. 

So what is complexity, exactly? 
Let me give you an example.

Previous research also found that complexity can predict earnings instability, so a more impenetrable 10-K can be a signal for difficulty within a company's walls.

Flickr / mikebehnken.

One study found that the more difficult the reporting was to read, the harder time even analysts had in understanding what was going on, leading to less agreement, lower accuracy in forecasts, and greater uncertainty.

That sentence has 61 words and 14 three-syllable words. According to the Gunning Fog Index (often called, for simplicity, the Fog index), it has a readability score of 21.38, meaning that you're most likely to understand everything on first reading if you've had over 21 years of education. Yikes. 

The Fog index is a classic measure of how accessible a document is: The more difficult it is to read, the less accessible it is to the reader. 

Does it work? 
This is a surprisingly useful tool for reading between the lines. In addition to the previous research you might have slept through in the 61-word sentence above, the NBER study found that a decrease in readability across an industry was followed by poor returns -- not always immediately, but pretty consistently.

The authors hypothesized that there is a level of unspoken cooperation in these changes; upon investigation, the idea holds up to scrutiny. 

Which industries are worst? 
The industries most likely to experience these industrywide drops in readability include health care, machinery, precious metals, computer software, and insurance. For example, 10-Ks in the technology industry became really complex in 2002 and 2003. Pretty funky, isn't it?

Industries with weaker evidence of this kind of coordinated complexity include apparel, pharmaceuticals, chemicals, communication, and business services.

What should I look out for?
You might make a note of those industries, but it's probably more useful to keep an eye on certain industry characteristics that could encourage unspoken cooperation.  

Industries that are exposed to significant negative shocks from external sources -- say, a heavy reliance on commodities prices -- are quite prone to it, especially if the companies are largely similar in their exposures to those shocks.

You can measure this by the proportion of news from the sector that is dominated by industrywide issues rather than individual companies. When everyone is basically in the same boat, all companies have more incentive to be vague about potential problems.

Flickr / RCB.

A reliance on equity compensation is also associated with industrywide decreases in readability, which makes sense if you think about it from the perspective of executives, who are probably very attuned to stock price movements.

The researchers also found that industries that foster interpersonal relationships and close-knit ties are also more prone to cooperation -- think hushed meetings rather than big, impersonal conventions.

Finally, size isn't a consistent predictor of opacity, but financial complexity is -- so keep a close eye on financial statements that make your eyes cross.

In the end, you'd always be wise to note if that 10-K you're poring over seems much more inaccessible than usual -- even if it's just one company and not the whole industry. Your inability to get to the bottom of what exactly is going on could very well be telling you something.