Tone Management and Earnings Management. A UK evidence of abnormal tone in CEO letters and abnormal accruals

Abstract

Background and Problem Definition: The CEO letter is one significant narrative document through which senior management have opportunity to express beliefs and values to their shareholders. The CEO letter is unregulated in its nature and thereby subject to management opportunism through tone management. Tone management could further be used to manipulate the perception of the firm, which causes information asymmetry. Similar to the purpose of tone management, accruals could be opportunistically managed in order to manipulate users’ perceptions of firm fundamentals. Thus, managers could through CEO letters employ tone management to potentially hide earnings management, and thereby mislead users about firm fundamentals. Purpose: The purpose of this thesis is to test the possible association between tone management in CEO letters and earnings management, using data from 2013 including firms listed on the London Stock Exchange. Subsequently, the intention is to investigate if earnings management and tone management are substitutes or complements. The purpose is additionally to test the relation between tone management in CEO letters and financial performance Research Design and Methodology: The theoretical framework of this thesis is used to develop hypotheses, which subsequently guide the research forward. In the execution phase, a customized dictionary is developed to fit with the purpose of the thesis. The execution phase continues in correlation and multiple regression analysis. The outcome of the statistical tests contributes to fulfill the purpose. Empirical Results and Analysis: In accordance with previous literature, the empirical results reveal a positive association between tone in CEO letters and financial performance. Strengthening the purpose and the contribution of this thesis, empirical evidences reveal that abnormal tone in CEO letters and abnormal accruals are positively associated. Concluding Remarks: The tone in CEO letters is generally positive regardless of management discretion. Furthermore the tone in CEO letters can be derived from firm performance, firm size and annual stock return. Finally, the findings indicate that tone management and earnings management through the use of abnormal tone and abnormal accruals functions as complements and are thus not substitutes.