Management’s Tone Change, Post Earnings Announcement Drift and Accruals

This study explores whether the Management Discussion and Analysis (MD&A) section of Form 10-Q and 10-K has incremental information content beyond financial measures such as earnings surprises and accruals. It uses a classification scheme of words into positive and negative categories to measure the tone change in the MD&A section relative to prior periodic SEC filings. The results indicate that short window market reactions around the SEC filing are significantly associated with the tone change of the MD&A section, even after controlling for accruals and earnings surprises. The authors show that management’s tone change adds significantly to portfolio drift returns in the window of two days after the SEC filing date through one day after the subsequent quarter’s preliminary earnings announcement, beyond financial information conveyed by accruals and earnings surprises. The drift returns are affected by the ability of the tone change signals to help predict the subsequent quarter’s earnings surprise, but cannot be completely attributed to this ability. The authors also find that the incremental information of management’s tone change depends on the strength of the firm’s information environment.