Do Fraudulent Firms Engage in Disclosure Herding?

Abstract

Using text-based analysis of 10-K MD&A disclosures, we find that fraudulent firms produce verbal disclosure that is abnormal relative to strong counterfactuals. This abnormal text predicts fraud out of sample, has a verbal factor structure, and can be interpreted to reveal likely mechanisms that surround fraudulent behavior. Using a conservative difference-based approach, we find evidence that fraudulent managers grandstand good performance and disclose fewer details explaining the sources of the firm's performance. We also find new interpretable verbal support for existing hypotheses suggested in the literature, for example, that some managers commit fraud in order to improve their odds of raising capital at low cost.