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Research Highlights

Smart Investors Read Between the Lines

 By Joshua Livnat, Professor Emeritus of Accounting

livnat mda research article

The research suggests that market participants use nonfinancial information such as management’s tone from MD&A disclosures, in addition to the financial information provided routinely by firms.

Words matter. Smart investors may not even realize it, but it appears that they pick up on subtle tone changes in the management discussion and analysis (MD&A) sections of companies’ periodic SEC filings.

NYU Stern Accounting Professor Joshua Livnat and co-authors compared the MD&A sections from companies’ Form 10-Q and Form 10-K reports and analyzed how the optimistic or pessimistic tone expressed by management, relative to prior filings, affected short-term market reactions following the filings – even after controlling for accruals and earnings surprises.

The researchers found that management’s tone in the discussion and analysis sections directly correlated with measurable short-term market reactions. The use of pessimistic words created a negative reaction, while a generally optimistic tone buoyed the market’s reaction.

Other interesting patterns emerged from Livnat’s research, published in the Review of Accounting Studies as “Management’s Tone Change, Post Earnings Announcement Drift and Accruals.”

For one, the drift in stock prices over the longer term was also affected significantly by tone change, not just by the straight financial information conveyed by accruals and earnings surprises.

Further, for those companies not closely followed by many analysts, tone change as a factor affecting market reactions became even more influential.

Said Livnat: “The research suggests that market participants use nonfinancial information such as management’s tone from MD&A disclosures, in addition to the financial information provided routinely by firms.”