Forward-Looking Md&A Disclosures and Market Efficiency(2/3)

This project extends prior research on the information content of qualitative MD&A disclosures in 10-K filings by examining whether they attenuate the post-earnings announcement drift and accrual anomaly. The first-year project argues that the forward-looking MD&A disclosures reduce information uncertainty and thus facilitate investors' and analysts' responses to previous earnings surprises. The more verifiable the forward-looking MD&A disclosures, the stronger their effects on reducing both investor and analyst underreaction to previous announced earnings will be. The second-year and the third-year projects suggest that managers have two major motivations to record discretionary accruals, namely, opportunistic purposes and signaling purposes. Thus, discretionary accruals are decomposed into signaling-driven and opportunistic-driven discretionary accruals. The second-year project argues that managers with signaling (opportunistic) motivations are more (less) likely to engage in forward-looking and Critical Accounting Policies disclosures, with a less (greater) amount of estimation in accruals. It is argued that these disclosures in the MD&A section of 10-K filings arising from managers' two major motivations will help inform investors of the persistence of both signaling-driven and opportunistic-driven discretionary accruals and thus attenuate the mispricing of signaling-driven (opportunistic-driven) discretionary accruals and total discretionary accruals. The third-year project argues that managers with signaling motivations to record discretionary accruals credibly use forward-looking disclosure tone in MD&A disclosures in conjunction with discretionary accruals to convey their private information of future prospects, whereas managers with opportunistic motivations to record discretionary accruals are less likely to disclose pseudo forward-looking tone to mislead investors for fear of potential litigation risk. Every sentence in the forward-looking MD&A disclosure is classified into one of four tones: optimistic, neutral, pessimistic, or uncertain, while net optimistic forward-looking tone is defined as the difference between the optimistic words and the pessimistic words scaled by total number of words in the MD&A disclosures. Holding information uncertainty constant, it is posited that signaling-type managers are more likely to disclose optimistic (pessimistic) forward-looking tone when facing income-increasing (income-decreasing) discretionary accruals, while net optimistic forward-looking tone is not related to opportunistic-driven discretionary accruals. In addition, the positive association between signaling-driven discretionary accruals and net optimistic forward-looking tone is more pronounced when facing lower information uncertainty. Furthermore, it is posited that signaling-type managers may choose either a confirmatory or non-confirmatory forward-looking tone depending on the extent of information uncertainty. The confirmatory (non-confirmatory) forward-looking tone means that the net optimistic forward-looking tone is in the same (opposite) direction as the signs of the signaling-driven discretionary accruals. It is posited that a confirmatory forward-looking tone helps inform investors of the two major motivations for recording discretionary accruals thereby attenuating the mispricing of signaling-driven (opportunistic-driven) discretionary accruals and total discretionary accruals, while non-confirmatory forward-looking tone is unable to attenuate these accrual anomalies.