Textual Analysis and Future Performance: Evidence From Item 1A and Item 7

Abstract

Although there is previous research on textual analysis in accounting, little is understood about the effects of the tone and sentiments of the text disclosed in annual report filings (10-K) on the investor assessment of the future performance of the firm. This study inks the tone and sentiments of the text disclosed in the corporate annual reports and expectations regarding the future performance of the firm. We focus on two specific sections of 10-K filings the risk factor disclosures (Item 1A) and the management’s discussion (Item 7) filling a gap in the accounting literature. There are two competing predictions regarding how the tone and sentiments of the text could impact the investor assessment about the future performance of the firm. First, the tone and sentiments of the text in Items 1A and 7 may have an effect on the investor assessment of the future performance of the firm. Second, only the tone and sentiments of Item 7 may have an effect on the investor assessment, given the fact that Item 1A only discusses the general risk factors that are present and not necessarily any specific risk factors to the firm. We find that only the tone and sentiments of the text in Item 7 has an effect on the investor assessment of the firm. This result helps explain the channels through which the tone and sentiments of the text impacts the future performance.