Tone and Capital Investments

Abstract

This study contributes to the literature on the relationship between the tone of financial disclosure narratives and capital investments. Specifically, we examine conditions where managers have differential incentives to disclose incrementally informative and misleading investment narratives. First, we argue that managers have fewer incentives to disclose misleading investment narratives if their content can be verified from concurrently disclosed numbers. Consistent with this argument, we find that the tone of a sample of 10-K disclosures is positively associated with current-period investments, suggesting that managers disclose incrementally informative narratives on the investment level. Second, we argue that, when the investment outcomes hamper their interests, managers have heightened incentives to disclose misleading investment efficiency narratives, as investment efficiency is not readily verifiable from concurrently disclosed numbers. Consistent with this argument, we find that the tone is more negatively associated with investment efficiency when firms: (a) undertake large vis a vis small investments (b) undertake vis a vis do not undertake new investments in the year (c) overinvest vis a vis underinvest and (d) decrease vis a vis increase investment efficiency. Overall, our results suggest that managers may disclose misleading narratives when the investment outcomes misalign with their interests.