Is Intangibles Talk Informative about Future Returns? New Evidence on Recognition versus Disclosure

Abstract

We construct a measure of intangible intensity --- intangibles talk --- based on discussions of intangibles in a firm's 10-K filings. This measure likely includes managers’ views about the successful outcomes of intangibles investments and not just ex-ante investments. The expected and realized outcomes of intangible investments could differ because many of intangible investments fail while only a few produce lottery-type payoffs. Our measure, derived from textual disclosures, is correlated with, but carries orthogonal information to, prior measures of intangibles that are largely derived from numbers presented in financial statements. We test the informativeness of our measure from its ability to earn future risk-adjusted returns. Portfolios formed on our measure outperform returns from book-to-market ratio as well as prior measures of intangible capital. Our strategy generates an average annual alpha of 3.37% from 1995 to 2020. Alphas are concentrated among stocks with higher arbitrage risk and reflect returns from positive surprises on future earnings announcement dates. These results are consistent with mispricing than risk explanation. Our paper suggests that textual discussion on intangibles, as a source of information on value creation, is underprocessed by the investors. We contribute to recognition versus disclosures literature in the context of intangibles. 

Keywords: 10-K filings, Intangibles talk, Intangible intensity, Recognition versus disclosure, Idiosyncratic volatility, Earnings surprise

JEL Classification: E22, G14, M41, O3