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    Tone Management.
    research summary posted July 16, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.04 Management Integrity, 06.06 Earnings Management 
    Tone Management.
    Practical Implications:

    The evidence indicates that tone manipulation succeeds in misleading investors, and that this effect is incremental to the effect of accruals management. An abnormally positive tone incites an overly optimistic immediate stock price response to the earnings announcement and a subsequent return reversal. The evidence indicates that abnormal positive tone contains negative information about future firm fundamentals, that firms tend to engage in tone management particularly when incentives to manipulate investor perceptions are high, and that investors are misinformed by tone management.


    Huang, X., Teoh, S. H., & Zhang, Y. 2014. Tone Management. Accounting Review 89 (3): 1083-1113.

    behavior finance, earnings management, market efficiency, qualitative disclosure, tone management, management integrity
    Purpose of the Study:

    The tone of the qualitative text in earnings press releases can be too optimistic or pessimistic relative to concurrent disclosures of quantitative performance. The authors call the choice of the tone level in qualitative text that is incommensurate with the concurrent quantitative information tone management. The authors investigate whether managers engage in tone management for informative or strategic purposes, and whether and to what extent the capital market discounts for strategic motives, if any, when reacting to earnings announcements.

    Earnings press releases, being voluntary, are not subject to explicit rules about the disclosure, so management has wide latitude in the qualitative presentation of the quantitative information. The authors are interested in studying how the tone of the press release affects readers’ response to the communication, and whether and how tone can be used as a tool to affect investors’ perception about the firm. As the old adage goes, “It’s not what you say; it’s how you say it.”

    A key goal for this paper is to test whether tone management in earnings press releases informs or misinforms investors. The authors examine how abnormal positive tone relates to future firm performance, whether abnormal tone is more likely used in situations where managerial strategic incentives to manipulate investor perception are present, and whether and how investors react to tone management at the time of, and subsequent to, the earnings announcements.

    Design/Method/ Approach:

    The authors obtain a sample of 14,475 observations of firm-year abnormal positive tone from the text of annual earnings press releases from PR Newswire and Business Wire, historical financial data from Compustat, stock returns from CRSP, analysts’ earnings forecasts data from I/B/E/S, seasoned equity offering (SEO) and merger and acquisition (M&A) effective dates from SDC, and option grants data for CEOs from ExecuComp. The sample period was 19972007.


    The evidence indicates that abnormal positive tone is associated with a more positive immediate market response to the earnings announcement and a more negative market response in one and two quarters subsequent to the announcement. The return reversal in the post-announcement period is strong evidence of an over-reaction to abnormal positive tone at the earnings announcement. Among firms that use both accruals and tone management in a consistent direction, the authors find that tone management is more likely in older firms and firms facing higher balance sheet bloat, as proxied by lagged assets scaled net operating assets, and so are more constrained in further upward accruals management. Abnormal positive tone is usually higher when firms just meet or beat past earnings or analysts’ consensus forecasts, when earnings are upwardly biased to such an extent as to require a future restatement, and before a new equity issuance or a merger or acquisition activity. When firms award stock options to CEOs, with an associated managerial incentive to reduce the share price, they prefer to manipulate abnormal tone downward. Overall, the evidence suggests that managers use tone management to mislead investors and other financial statement users.

    Risk & Risk Management - Including Fraud Risk
    Earnings Management, Management Integrity