Narrative tone and earnings persistence

Abstract

This study contributes to the accounting literature on the intersection between earnings quality and the linguistic features of firms’ financial disclosures. Specifically, it examines the relationship between earnings persistence as an attribute of earnings quality and the tone of United Kingdom annual reports. The expectations-adjustment hypothesis suggests that firms with more persistent earnings streams have incentives to signal their superior earnings quality to capital providers by increasing the positive tone of financial disclosures. Consistent with this hypothesis, this study provides evidence of a positive association between the annual report tone and earnings persistence. Additional analysis reveals that this association is less pronounced in technology firms than non-technology firms. Separating the sample into profit firms and loss firms suggests that the tone is positively associated with the persistence of profits but exhibits no association with the persistence of losses. Disaggregating the tone into positive and negative components indicates that negative tone has a stronger and more negative association with earnings persistence than positive tone. Further, negative tone is negatively associated with earnings persistence in both profit firms and loss firms. In contrast, positive tone is not associated with earnings persistence in profit firms but is negatively associated with earnings persistence in loss firms.