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    Narrative Disclosure and Earnings Performance: Evidence from...
    research summary posted March 10, 2015 by Jennifer M Mueller-Phillips, last edited March 10, 2015, tagged 09.0 Auditor Judgment, 09.06 Adequacy of Disclosure 
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    Title:
    Narrative Disclosure and Earnings Performance: Evidence from R&D Disclosures
    Practical Implications:

    This study claims that, “our understanding of firms' R&D disclosure decisions is limited, and therefore the study’s results provides new insights about these decisions by showing that firms adjust their narrative R&D disclosures in response to changes in current earnings performance.

    Furthermore, this study’s findings, “increase our understanding of firms' narrative disclosure decisions, an important disclosure channel used to convey contextual information about a firm's activities beyond financial statement numbers.”

    • Findings are “not necessarily generalizable to other disclosures,” however, “the unique characteristics of the R&D disclosure setting make it useful to examine narrative disclosure decisions.”
    • Study provides, “original evidence that earnings performance can affect distinct types of narrative disclosures differently.”

    “These findings suggest that narrative disclosures should not be generalized as a whole and emphasize for future research the importance of considering disclosure type in the formation of hypotheses and empirical tests.”

    Citation:

    Kenneth J. Merkley (2014) Narrative Disclosure and Earnings Performance: Evidence from R&D Disclosures. The Accounting Review: March 2014, Vol. 89, No. 2, pp. 725-757

    Keywords:
    narrative disclosure, research and development, earnings, content analysis
    Purpose of the Study:

    In its introduction, this study calls on a particular passage to elucidate its central purpose:

    “Narrative disclosure provides a channel for managers to convey contextual information about their firms to market participants. This type of disclosure can bridge the gap between a firm's financial statement numbers and its underlying business fundamentals. For narrative disclosure to perform this function, managers must be willing to modify their disclosures based on their firms' changing financial performance and investors' changing information needs.”

    Thus, “this study examines whether managers adjust their narrative disclosures based on current earnings performance and whether such disclosures are informative to market participants.”

    Design/Method/ Approach:

    This study includes firm-year observations from 1996 to 2007 and requires that data be available from the Compustat, CRSP, and SEC EDGAR databases. It was required that all observations have at least $1 million in assets and report non-zero R&D expense. This study’s sample includes 22,482 firm-year observations.

    This study was conducted through measuring narrative R&D disclosure quantity by using a computerized content analysis of 10-K filings

    Findings:

    Broadly speaking, this study finds that managers adjust R&D disclosures based on earnings performance to provide relevant information rather than to obfuscate performance.

    • Earnings performance correlates negatively with total narrative R&D disclosure quantity.
    • Narrative R&D disclosure is positively related to analyst following and earnings forecast accuracy and negatively related to analyst forecast dispersion
    • Greater narrative R&D disclosure is associated with higher 10-K information content and lower information asymmetry
    Category:
    Auditor Judgment
    Sub-category:
    Adequacy of Disclosure