Express Yourself: Why Managers’ Disclosure Tone Varies Across Time and What Investors Learn from It

We examine the extent to which variation in a given manager’s disclosure tone across time is related to a firm’s cost of capital. In theory, variation in a manager’s tone across time should correspond to the firm’s underlying economic uncertainty. However, managers face incentives to disclose positive information and therefore disclosure tone may not meaningfully reflect a firm’s economic uncertainty. We offer three main findings. First, we find that variation in disclosure tone is positively associated with quantitative measures of firm risk. This suggests that, on average, manager tone variation meaningfully reflects a firm’s economic uncertainty. Second, we find that variation in disclosure tone is positively associated with contemporaneous market-based measures of firm risk. This suggests that investors react to the information conveyed by disclosure tone variation. Finally, we find that variation in disclosure tone is associated with future market-based measures of firm risk. This suggests that investors do not fully incorporate the information conveyed by disclosure tone variation. Overall, our results suggest that managers moderate their tone across time to meaningfully reflect firm risk and that investors do not fully react to this signal.