Predicting Stock Market Returns Based on the Content of Annual Report Narrative: A New Anomaly

Wisniewski, Tomasz Piotr and Yekini, Liafisu Sina (2014): Predicting Stock Market Returns Based on the Content of Annual Report Narrative: A New Anomaly.

Abstract

This paper uses the tools of computational linguistics to analyze the qualitative part of the annual reports of UK listed companies. More specifically, the frequency of words associated with praise, concreteness and activity is measured and used to forecast future stock returns. We find that our language indicators predict subsequent price increases, even after controlling for a wide range of factors. Elevated values of the linguistic variables, however, are not symptomatic of exacerbated risk. Consequently, investors are advised to peruse the annual report narrative, as it contains valuable information that may still not have been discounted in the prices.

• Item Type: MPRA Paper
• Language: English
• Keywords: Content Analysis, Annual Reports, Stock Market Returns
• Subjects: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M41 - Accounting

References

Abrahamson, E. & Amir, E. (1996). The information content of the presidents letter to shareholders, Journal of Business Finance & Accounting 23 (8), pp. 1157-1182.

Amihud, Y. (2002). Illiquidity and stock returns: cross-section and time-series effects, Journal of Financial Markets 5 (1), pp. 31-56.

Antweiler, W. & Frank, M.Z. (2004). Is all that talk just noise? The information content of internet stock message boards, Journal of Finance 59 (3), pp. 1259-1294.

Ball, R. & Brown, P. (1968). An empirical evaluation of accounting income numbers, Journal of Accounting Research 6 (2), pp. 159-178.

Banz, R.W. (1981). The relationship between return and market value of common stocks, Journal of Financial Economics 9 (1), pp. 3-18.

Bartov, E., Givoly, D. & Hayn, C. (2002). The rewards to meeting or beating earnings expectations, Journal of Accounting and Economics, 33 (2), pp. 173-204.

Beattie, V. & Jones, M. J. (1992). The use and abuse of graphs in annual reports: Theoretical framework and empirical studies, Accounting and Business Research 22 (88), pp. 291-303.

Beattie, V., Dhanani, A. & Jones, M. J. (2008). Investigating presentational change in U.K. annual reports, International Journal of Business Communications 45 (2), pp. 181-222.

Bhana, N. (2009). The chairman’s statements and annual reports: Are they reporting the same company performance to investors?, Investment Analysts Journal 70, pp. 32-46.

Bhandari, L.C. (1988). Debt/equity ratio and expected common stock returns: Empirical evidence, Journal of Finance 43 (2), pp. 507-528.

Bhattacharya, U., Galpin, N., Ray, R. & Yu, X. (2009). The role of the media in the Internet IPO bubble, Journal of Financial and Quantitative Analysis 44 (2), pp. 657-682.

Binder, J. R., Westbury, C. F., McKieran, K. A., Possing, E. T. & Medler, D. A. (2005). Distinct brain systems for processing concrete and abstract concepts, Journal of Cognitive Neuroscience 17(6), pp. 905-917.

Bollerslev, T. (1986). Generalized autoregressive conditional heteroskedasticity, Journal of Econometrics 31 (3), pp. 307-327.

Brown, L.D. & Caylor, M.L. (2005). A temporal analysis of quarterly earnings thresholds: Propensities and valuation consequences, Accounting Review 80 (2), pp. 423-440.

Buhr, N. (1998). Environmental performance, legislation and annual report disclosure: The case of acid rain and Falconbridge, Accounting, Auditing & Accountability Journal 11 (2), pp. 163-190.

Burchell, S., Clubb, C., Hopwood, A. & Hughes, J. (1980). The roles of accounting in organizations and society, Accounting, Organizations and Society 5 (1), pp. 5-27.

Case, K.E. & Shiller, R.J. (2003). Is there a bubble in the housing market?, Brooking Papers on Economic Activity 2, pp. 299-362.

Chatterjee, S. and Price, B. (1991). Regression diagnostics, John Wiley, New York.

Chen, P. & Zhang, G. (2007). How do accounting variables explain stock price movements? Theory and evidence, Journal of Accounting and Economics 43 (2-3), pp. 219-244.

Clatworty, M. & Jones, M. J. (2003). Financial reporting of good news and bad news: Evidence from accounting narratives, Accounting and Business Research 33 (3), pp. 171-185.

Cooper, D.J. & Sherer, M.J. (1984). The value of corporate accounting reports: Arguments for a political economy of accounting, Accounting, Organizations and Society 9 (3-4), pp. 207-232.

Coy, D., Fischer, M. & Gordon, T. (2001). Public Accountability: A new paradigm for college and university annual reports, Critical Perspectives on Accounting 12 (1), pp. 1-31.

Das, S.R. & Chen, M.Y. (2007). Yahoo! for Amazon: Sentiment extraction from small talk on the Web. Management Science 53 (9), pp. 1375–1388.

Davis, A.K., Piger, J.M. & Sedor, L.M. (2012). Beyond the numbers: Measuring the information content of earnings press release language, Contemporary Accounting Research 29(3), pp. 845-868.

Demers, E. & Vega, C. (2010). Soft information in earnings announcements: News or noise?, INSEAD Faculty & Research Working Paper 2010/33/AC.

Dröge, C., Germain, R. & Halstead, D. (1990). A note on marketing and the corporate annual report: 1930-1950, Journal of the Academy of Marketing Science 18 (4), pp. 355-364.

Easton, P.D. & Zmijewski, M.E. (1989). Cross-sectional variation in the stock market response to accounting earnings announcements, Journal of Accounting and Economics, 11 (2-3), pp. 117-141.

Engle, R.F. (1982). Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation, Econometrica 50 (4), pp. 987-1008.

Fama, E.F. (1970). Efficient capital markets: A review of theory and empirical work, Journal of Finance 25 (2), pp. 383-417.

Fama, E.F. & French, K.R. (1993). Common risk factors in the returns on stocks and bonds, Journal of Financial Economics 33 (1), pp. 3-56.

Fama, E.F. & French, K.R. (1996). The CAPM is wanted, dead or alive, Journal of Finance 51 (5), pp. 1947-1958.

Frazier, K. B., Ingram, R.W. & Tennyson, B.M. (1984). A methodology for the analysis of narrative accounting disclosures, Journal of Accounting Research 22 (1), 318-331.

Grimmer, J. & Steward, B.M. (2013). Text as data: The promise and pitfalls of automated content analysis methods for political texts, Political Analysis 21 (3), pp. 1-31.

Guthrie, J. & Parker, L.D. (1989). Corporate social reporting: A rebuttal of legitimacy theory, Accounting and Business Research 19 (76), pp. 343-352.

Healy, P.M. & Wahlen, J.M. (1999). A Review of the Earnings Management Literature and Its Implications for Standard Setting, Accounting Horizons 13 (4), pp. 365-383.

Henry, E. (2008). Are investors influenced by how earnings press releases are written?, Journal of Business Communication, 45 (4), pp. 363-407.

Hildebrandt, H.W. & Snyder, R.D. (1981). The Pollyanna hypothesis in business writing: Initial results, suggestions for research, International Journal of Business Communication, 18 (1), pp. 5-15.

Hooks, J., Coy, D. & Davey, H. (2001). The annual reports of New Zealand electricity companies: Assessing quality, Pacific Accounting Review 13 (2), pp. 35-69.

Hughes, J.S. & Ricks, W.E. (1987). Associations between forecast errors and excess returns near to earnings announcement, Accounting Review, 62 (1), pp. 158-175.

Kothari, S.P. (2001). Capital markets research in accounting, Journal of Accounting and Economics 31 (1-3), pp. 105-231.

Lanis, R. & Richardson, G. (2013). Corporate social responsibility and tax aggressiveness: A test of legitimacy theory, Accounting, Auditing & Accountability Journal 26 (1), pp. 75-100.

Lee, T. (1994). The changing form of the corporate annual report, Accounting Historians Journal 21 (1), pp. 215-232.

Lesmond, D.A., Ogden, J.P. & Trzcinka , C.A. (1999). A new estimate of transaction costs, Review of Financial Studies 12 (5), pp. 1113-1141.

Lev, B. (1989). On the usefulness of earnings and earnings research: Lessons and directions from two decades of empirical research, Journal of Accounting Research 27, pp. 153-192.

Li, F. (2008). Annual report readability, current earnings, and earnings persistence, Journal of Accounting and Economics 45 (2-3), pp. 221-247.

Lintner, J. (1965). The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets, Review of Economics and Statistics 47(1), pp. 13-37.

Livnat, J. & Zarowin, P. (1990). The incremental information content of cash-flow components, Journal of Accounting and Economics 13 (1), pp. 25-46.

Mandelbrot, B. (1963). The variation of certain speculative prices, Journal of Business 36 (4), pp. 394-419.

Marquering, W., Nisser, J. & Valla, T. (2006). Disappearing anomalies: A dynamic analysis of the persistence of anomalies, Applied Financial Economics 16 (4), pp. 291-302.

McConnell, D., Haslem, J.A. & Gibson, V.R. (1986). The president’s letter to shareholders: A new look, Financial Analysts Journal 42 (5), Sep-Oct, pp. 66-70.

McKinstry, S. (1996) Designing the annual reports of Burton plc from 1930 to 1994, Accounting, Organizations and Society 21 (1), pp. 89-111.

Mossin, J. (1966). Equilibrium in a capital asset market, Econometrica 34(4), pp. 768-783.

Neu, D., Warsame, H. & Pedwell, K. (1998). Managing public impressions: Environmental disclosures in annual reports, Accounting, Organizations and Society 23 (3), pp. 265-282.

Nobes, C. & Parker, R. (2008). Comparative international accounting, 10th Edition, Pearson Education Limited, Essex: England.

O’Donovan, G. (2002). Environmental disclosures in the annual report: Extending the applicability and predictive power of legitimacy theory, Accounting, Auditing & Accountability Journal 15 (3), pp. 344-371.

Paivio, A. (1971). Imagery and verbal process, Holt: Rinehart & Winston, New York.

Paivio, A (1986). Mental representations: A dual-coding approach, Oxford University Press, New York.

PricewaterhouseCoopers (2009). A snapshot of FTSE 350 reporting: Compliance mindset suppresses effective communication, available at pwc.blogs.com/files/a-snapshot-of-ftse-350-reporting.pdf, last accessed 24th July 2014.

Rogers, J.L., Van Buskirk, A. & Zechman, S.L.C. (2011). Disclosure tone and shareholder litigation, Accounting Review 86 (6), pp. 2155-2183.

Rosenberg, B., Reid, K. & Lanstein, R. (1985). Persuasive evidence of market inefficiency, Journal of Portfolio Management 11 (3), pp. 9-16.

Rutherford, B.A. (2005). Genre Analysis of Corporate Annual Report Narratives: A corpus linguistics-based approach, International Journal of Business Communications 42 (4), pp. 348-378.

Schwert, G.W. (2003). Anomalies and market efficiency. In Constantinides, G.M, Harris, M. & Stulz, R.M. (Eds) Handbook of the Economics of Finance 1 (B), pp. 939-974.

Sharpe, W.F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk, Journal of Finance 19(3), pp. 425-442.

Shiller, R. J. (1981). Do stock prices move too much to be justified by subsequent changes in dividends?, American Economic Review 76 (3), pp. 483–98.

Shumway, T. (2001). Forecasting bankruptcy more accurately: a simple hazard model, Journal of Business 74 (1), pp. 101-124.

Smith, M. & Taffler, R.J. (1995). The incremental effect of narrative accounting information in corporate annual reports, Journal of Business Finance & Accounting 22 (8), pp. 1195-1210.

Smith, M. & Taffler, R.J. (2000). The chairman’s statement: A content analysis of discretionary narrative disclosures, Accounting, Auditing & Accountability Journal 13 (5), pp. 624-646.

Sonholtz, C. (2008). The information content of earnings announcements in Denmark, International Journal of Managerial Finance, 4 (1), pp. 4-36.

Stanton, P. & Stanton, J. (2002). Corporate annual reports: Research perspectives used, Accounting, Auditing & Accountability Journal 15 (4), pp. 578-500.

Stittle, J. (2002). UK corporate ethical reporting – A failure to inform: Some evidence from company annual reports, Business and Society Review 107 (3), pp. 349-370.

Subramaninan, R., Insley, R.G & Blackwell, R.D. (1993). Performance and readability: A comparison of annual reports of profitable and unprofitable corporations, International Journal of Business Communication 30 (1), pp. 49-61.

Swales, G.S. Jr. (1988). Another look at the president’s letter to stockholders, Financial Analysts Journal 44 (2), Mar. – Apr., pp. 71-73.

Tetlock, P. C. (2007). Giving content to investor sentiment: The role of media in the stock market, Journal of Finance 62 (3), pp. 1139-68.

Tetlock, P. C., Saar-Tsechansky, M., & Macskassy, S. (2008). More than words: Quantifying language to measure firms’ fundamentals, Journal of Finance 63 (3), pp. 1437-67.

Thomas, J. (1997). Disclosure in the marketplace: The making of meaning in annual reports, Journal of Business Communications 34 (1), pp. 47-66.

Wisniewski, T.P. (2004). Reexamination of the link between insider trading and price efficiency, Economic Systems, 28 (2), pp. 209-228.

Wisniewski, T.P. & Lambe, B. (2013). The role of media in the credit crunch: The case of the banking sector, Journal of Economic Behavior and Organization 85, pp. 163-175.

Wisniewski, T.P. & Moro, A. (in press). When EU leaders speak, the markets listen, European Accounting Review, forthcoming.