Managerial Incentives and the Language in Management Forecast Press Releases

Using a sample of 2,085 voluntarily-provided “unbundled” management earnings forecasts in 1,372 unique press releases during the 1997-2006 period, we find significant incremental pricing effects for linguistic sentiment included in management forecast press releases. Our setting is distinct from those examined in prior linguistic studies in that forecasts are voluntarily issued, incentive-driven disclosures that are unaudited, unstructured, and likely noisier than earnings realizations. The pricing effects that we document are strong relative to the accompanying hard management forecast news and stronger when the linguistic sentiment is provided in a pure forecast setting and not bundled with an earnings release. Sentiment and the unexpected earnings conveyed by the hard forecast are positively correlated, suggesting that managerial language is being used to reinforce the information contained in the hard forecasts. Consistent with many management incentives to strategically delay bad news and inflate good news, and with “cheap talk” models that entail a cost to lying, we document that investors react more strongly to net negative relative to net positive sentiment (incremental to a stronger reaction to bad hard forecast news). Net optimism is decreasing in the probability of litigation, the likelihood of financial distress, and in expected political costs, but greater for annual forecasts, for more frequent forecasters, and post-Regulation Fair Disclosure. After controlling for hard news and the stronger pricing effects of net negative sentiment, our capital market tests find little evidence that investors view sentiment as being biased when such situational incentives are in play, except for some evidence of the discounting of the typically more optimistic sentiment in annual forecasts. Furthermore, our findings are consistent with the threat of litigation and more frequent forecasting rendering sentiment more credible. Finally, we detect a positive interaction effect between sentiment and hard forecast news, consistent with the use of language to reinforce rather than overturn the hard news, and with the market’s ascribing credibility to managerial linguistic sentiment. In summary, aside from the finding that net pessimistic language is strategically delayed (or that net pessimistic language is more credible), most of our evidence is not consistent with managers using non-credible language to inflate prices, and taken as a whole, is consistent with the language in management forecasts playing a significant role in the price formation process. JEL Classifications: G14; D82; M41