Narrative Disclosure and Earnings Performance: Evidence from R&D Disclosures

Abstract:     
This paper examines whether earnings performance relates to the amount of narrative disclosure about R&D activities that firms provide concurrently in their financial reports. While R&D activities are an important source of firm growth and value, our understanding of R&D disclosure decisions is limited. In addition, the unique nature of R&D investments and the limitations of financial statements to communicate information about their value highlight the role of narrative disclosure as a supplement to the financial statements. Based on a detailed analysis of R&D-related disclosures in financial reports from 1996-2007, I predict and find that current earnings performance (adjusted for R&D expense) is negatively related to the quantity of narrative R&D disclosure. Using a content analysis of the detail, tone, and readability of narrative R&D disclosure, I find that the relation between earnings performance and R&D disclosure is consistent with managers providing more information to help investors, rather than using disclosure to spin or obfuscate the firm’s performance. Finally, I provide evidence that narrative R&D disclosure provides useful information to market participants as it significantly affects sell-side analyst behavior, disclosure information content, and information asymmetry.

Number of Pages in PDF File: 62

Keywords: Corporate Disclosure, Research and Development, Earnings Performance, Narrative Disclosure, Qualitative Disclosure

JEL Classification: M41, G10, O31, O32

working papers series