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This study explores whether the management discussion and analysis (MD&A) section of Forms 10-Q and 10-K has incremental information content beyond financial measures such as earnings surprises and accruals. It uses a classification scheme of words into positive and negative categories to measure the tone change in the MD&A section relative to prior periodic SEC filings. Our results indicate that short window market reactions around the SEC filing are significantly associated with the tone change of the MD&A section, even after controlling for accruals and earnings surprises. We show that management's tone change adds significantly to portfolio drift returns in the window of 2 days after the SEC filing date through 1 day after the subsequent quarter's preliminary earnings announcement, beyond financial information conveyed by accruals and earnings surprises. The drift returns are affected by the ability of the tone change signals to help predict the subsequent quarter's earnings surprise but cannot be completely attributed to this ability. We also find that the incremental information of management's tone change depends on the strength of the firm's information environment.

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This study explores whether the Management Discussion and Analysis (MD&A) section of Form 10-Q and 10-K has incremental information content beyond financial measures such as earnings surprises, accruals and operating cash flows (OCF). It uses a well-established classification scheme of words into positive and negative categories to measure the tone change in a specific MD&A section as compared to those of the prior four filings. Our results indicate that short window market reactions around the SEC filing are significantly associated with the tone of the MD&A section, even after controlling for accruals, OCF and earnings surprises. We also show that the tone of the MD&A section adds significantly to portfolio drift returns in the window of two days after the SEC filing date through one day after the subsequent quarter's preliminary earnings announcement, beyond financial information conveyed by accruals, OCF and earnings surprises. The incremental information of tone change is larger the weaker is the firm's information environment. The Incremental Information Content of Tone Change in Management Discussion and AnalysisThere is a substantial body of literature in financial economics and accounting that examines the value relevance and information content of quantitative factors in the pricing of stocks. While economic and statistical modeling has become more sophisticated over the years, the somewhat disconcerting conclusion that seems to have emerged is that these quantitative factors inadequately explain movement of stock prices.Persuasive evidence of this is provided by Shiller (1981), Roll (1988), and Cutler et al. (1989), and others in the finance literature, who demonstrate that stock prices do not respond to change in quantitative measures of firm fundamentals as would be expected from models incorporating only quantitative variables of firm performance. In the accounting literature, Thiagarajan (1993), and Lev (1996) earnings and stock returns on the day after the publication of these news articles. They find that the proportion of negative words in these news stories (especially, negative words about a firm's fundamentals) do provide information about future earnings even after controlling for other factors; the higher the proportion of negative words the larger are the negative shocks to future earnings. In addition, they provide persuasive evidence that potential profits could be made by trading on negative words from DJNS, a timely news service (but not from the one day old information published in the WSJ). 2The two Tetlock papers remain among the first of their kind to assess the predictive content of non-quantitative verbal information and are the main motivators of our work. 3 By focusing on news stories in media, their work is more concerned with 1 Following the initial impact on stock prices due to the media pessimism factor, the prices of indexes of smaller stocks reverse more slowly than those of large firms. In addition, he also provides persuasive evidence to show that pessimism i...