Does the rhetoric always hide bad intention: annual report’s tone and stock crash risk

Abstract

ABSTRACTIn this paper, by examining the relationship between tone and stock crash risk, we investigate whether tone embedded in annual reports transmits information to the market or it is just a way of impressing management. We consider the optimism of tone as the construct of public information received by investors, and the truthfulness of tone as the construct of private information held by the management, respectively. We find that, overall, the optimism of tone in the annual report has no significant impact on stock crash risk in the year following the release of the annual report. However, after taking the truthfulness of tone into account, we find that when the tone is not true, the stock crash risk in the following year will increase if tone becomes more optimistic, indicating that an overly positive tone is likely to be the result of management hiding some bad news or releasing false good news for their self-interest. On the other hand, when the tone in annual reports is true, the positive correlation between tone and crash risk will be significantly suppressed, indicating that positive language expresses managers’ real thoughts, without bad intention.