[We’re pleased to welcome authors Dr. Mohamed M. Tailab and Dr. Marshall J. Burak of Lincoln University. They recently published an article in International Journal of Business Communication entitled “Examining the Effect of Linguistic Style in an MD&A on Stock Market Reaction,” which is currently free to read for a limited time. Below, they discuss this research:]
Language as the currency of most human social processes can be converted to words. Investors and market participants attach very different connotations to the words, rely more on intuition than hard data, and react more to the verbal tone. Quantitative information contained in financial annual reports in general and in an MD&A in particular does not provide a complete picture to the investors about the expected firm value. So, the need arises to analyze the effect of narrative disclosures on market reaction as well. In addition, analyzing narrative disclosures is more easily understood than quantitative data, but at the same time it offers a different perspective. This initiated our research interests and concerns to explore in depth the impact of linguistic style in narrative disclosures on decision makers.Therefore, we decided to investigate the effect of language used in the MD&A between the speaker (management) and the listeners (investors), which in turn influences market reaction. We had hypothesized that the stock market (return and risk) has a significant response to the linguistic tone contained in the MD&A. Even though the initial hypotheses have never been proven, this study proves principles about the usefulness of an MD&A to investors.
This work expands on the understanding of the business communication literature by using an interdisciplinary approach. This approach has emerged the narrative disclosures with applied linguistic and market reaction. To this end, this paper is the first to use the partial least squares – structural equation modeling (PLS-SEM) approach and contributes to the existing body of knowledge in several ways including (a) a new approach to strengths, (b) evaluation of MD&A content, (c) proof that MD&A length does not play a strong role in market reaction, and (d) findings that capital assets pricing model (CAPM) or Farm-French models are more reliable than the realized volatility.
The study indicates that the average of negative tone is greater than the average of positive words in the MD&A. This may be because the study period started in 2010, there is a possibility that the financial crisis still has an effect on the verbal tone of MD&A reports, and allows the management writers to be more conservative. One interesting observation is that the linguistic content in an MD&A was not consistent with financial performance. It can be concluded that that management most likely does not use its financial performance as a guide for writing the MD&A, or maybe it has another criterion for delivering its message to the investors.
A challenging aspect of this work is that using dictionaries built by researchers in other fields (e.g., psychology) may not be appropriate for a content analysis of financial reports. We have limited our research by neglecting the investors’ types and their preferences. So, it would be better if future researches studied the investors’ preferences, what information investors need to find in the MD&A before making their decisions.The study recommends conducting a more efficient analysis of the narrative disclosures to investigate whether management writers communicate truthful information to investors by offering relevant data about financial performance.
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