Narrative Tone and Share Price Anticipation of Earnings

Abstract

We contribute to the literature on the intersection between the lexical features of firms’ financial disclosures and prices leading earnings by examining the relationship between the tone of financial disclosures and share price anticipation of earnings. In efficient markets, if managers disclose incrementally informative (misleading) narratives on the firm-fundamentals, then the tone is expected to improve (deteriorate) the share price informativeness of future earnings. However, managerial incentives to disclose incrementally informative versus misleading narratives is expected to differ between profit firms and loss firms. Using a sample of 10-K disclosures, we find that the tone improves (deteriorates) the share price informativeness of future earnings in profit (loss) firms. Segregating the tone into positive and negative tonal components suggests that both components contribute towards improving (deteriorating) the share price informativeness of future earnings in profit (loss) firms. Additional analysis reveals that the association of the tone (and both positive and negative tonal components) with the future earnings response coefficient (FERC) is stronger in short disclosures than in long disclosures, suggesting that investors find the tone in short disclosures to be better predictors of future earnings than long disclosures.