When the Use of Positive Language Backfires: The Joint Effect of Language Sentiment, Readability, and Investor Sophistication on Earnings Judgments

41 Pages Posted: 3 Jan 2014

See all articles by Hun-Tong Tan

Hun-Tong Tan

Nanyang Business School, Nanyang Technological University

Elaine Wang

University of Massachusetts Amherst

Bo Zhou

Shanghai University of Finance and Economics

Date Written: Dec 9, 2013

Abstract

Recent studies document that market participants react positively to the positive language sentiment or tone embedded in financial disclosures, and that investors’ reactions to negative news are more muted with poor disclosure readability. However, while language sentiment and readability co-occur in practice, their joint effects remain largely unexplored. In an experiment with MBA students as participants, we investigate how the effect of language sentiment varies with readability and investor sophistication level. We find that language sentiment influences investors’ judgments when readability is low, but not when readability is high. Specifically, when readability is low, disclosures couched in positive language lead to higher earnings judgments for less sophisticated investors, but lower earnings judgments for more sophisticated investors. These findings show that the main effects of readability and language sentiment documented in prior studies have boundary effects, and may reverse when both variables are jointly considered along with investor sophistication.

Keywords: language sentiment, readability, investor sophistication

JEL Classification: C91, G18, M41, M43, M44

Suggested Citation

Tan, Hun-Tong and Wang, Elaine (Ying) and Zhou, Bo, When the Use of Positive Language Backfires: The Joint Effect of Language Sentiment, Readability, and Investor Sophistication on Earnings Judgments (Dec 9, 2013). Journal of Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2373996

Hun-Tong Tan (Contact Author)

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore
+65 6790 4819 (Phone)
+65 6793 7956 (Fax)

Elaine (Ying) Wang

University of Massachusetts Amherst ( email )

Amherst, MA 01003-4910
United States
413-545-7613 (Phone)

Bo Zhou

Shanghai University of Finance and Economics ( email )

No. 777 Guoding Road, Shanghai
Shanghai, 200433
China

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