Academic

Loughran & McDonald on Word Choice, Measurement, & 10-Ks

By Lawrence Solum

Tim Loughran and Bill McDonald (University of Notre Dame and University of Notre Dame) have posted When is a Liability Not a Liability? on SSRN. Here is the abstract:

Previous research uses negative word counts as a way to measure the tone of a text. We show that word lists developed for other disciplines substantially misclassify financial text. In a large sample of 10-Ks during 1994-2007, more than half of the word count identified as negative by the commonly used Harvard-IV-4 Psychological Dictionary represents words that typically do not have negative financial meaning. Words like tax, cost, board, foreign, vice, and liability, simply describe company operations. We develop an alternative negative word list that better reflects the tone of financial text, and examine five other word classifications (positive, uncertain, litigious, strong modal words, and weak modal words). Our new word classification measures are significantly related to 10-K file date returns, post-file date returns, return volatility, allegations of accounting fraud, and company material weakness disclosures. We also provide evidence that word choice in 10-Ks is affected by recent legislation.

Full post as published by Legal Theory Blog on February 10, 2009 (boomark / email).