Do Attributes of Management’s Explanations of Financial Performance Matter for Analysts? An International Perspective

Abstract

Aerts and Tarca (2010) study attributes of performance explanations in management commentary reports provided by 172 companies from five industries in the USA, Canada, the UK and Australia. They report that, compared to their counterparts in the UK and Australia, companies from the USA and Canada are generally less assertive and less defensive in explicit causal framing of accounting outcomes. They are also more extensive and formal in their explanations, relying more heavily on accounting-technical language in explaining performance outcomes. We investigate whether these differential attributional properties have economic relevance by considering their relationship with analyst forecast dispersion. Using a factor analysis based on firm-level characteristics of explanatory statements for 158 companies included in the above study, we find that defensiveness and extensiveness of performance explanations are negatively associated with analyst forecast dispersion, while assertiveness and formality are not. Our results suggest that analysts benefit from more detailed explanations and that they pick up defensive explanations while possibly disregarding more assertive explanations. Not surprisingly, the use of more technical-accounting explanations does not serve to reduce dispersion in forecasts. Our study brings together two strands of literature, being studies of explanatory patterns in narrative reports and studies investigating usefulness of narrative reports for analysts.

This chapter includes the paper originally titled “The effect of Institutional Setting on Attributional Content in Management Commentary Reports” and discussed at the Fourth International Workshop on Accounting and Regulation in 2007. We thank seminar participants at the European Accounting Association Conference Lisbon 2007, the EIASM Accounting Regulation Conference Siena 2007, the AAA International Accounting Section and IAAER Joint 2008 Midyear Conference, the University of Glasgow and the University of Queensland for their helpful comments on the material in this article and the related study Aerts and Tarca (2010). We acknowledge the financial support of the UWA Business School and of the National Bank of Belgium. We thank the following research associates for their assistance: Serene Seah, Morris Eggleston, Pirya Altraide, Jamille Payne, Hui Li Siow, Eric Vermuyten and Christophe Nauts.

Appendices

Appendix 1

Aerts and Tarca (2010) Explanation of Terms: Attributional Content Characteristics

Attributional statement	Antecedent—consequence statement. One or more sentences (or part thereof) in which an outcome or effect (relating to firm’s financial performance, i.e. revenue, expense or net income/earnings/profits item) is linked to one or more antecedents for that outcome, e.g. Sales increased due to strong consumer demand and an increase in retail outlets
Explained effects
Company/division	The statement relates to the companies as a whole and/or to a division within the company, e.g. Sales for the company decreased in the current year (company). However, there was strong performance of the Orange division, following restructuring carried out last year (division)
Valence of effect/Positivity	A positive effect is favourable for the company (e.g. revenue increasing, expense decreasing). A negative effect is not favourable (e.g. expenses have increased, without a commensurate increase in revenue)
Prospectivity	The statement relates to a future event or period, e.g. Sales are expected to increase in the following year due to improved economic conditions including lower interest rates
Explanatory effort
Depth of explanations	Number of explanations for each statement of effect (may be one or more), e.g. Sales increased due to strong consumer demand and an increase in retail outlets (one effect, two antecedents)
Density of explanations	Number of a firm’s attribution statements relative to number of items of disclosure about results of operations in MD&A, OFR or equivalent
Formal language use
Technical-accounting versus causal explanation	Technical-accounting explanations are based on technical-accounting language and are of an intermediary nature (e.g. Profit increased because margins improved). Causal explanations refer to other types of explanation (e.g. Sales revenue increased due to stronger demand and a more buoyant economy)
Formality (informality) bias	Greater (lesser) use of technical-accounting explanations relative to causal explanations
Informality bias on positives	(Relative) tendency to explain positive effects more in explicitly causal terms than in accounting-technical language
Formality bias on negatives	(Relative) tendency to explain negative effects more in accounting-technical language than in explicitly causal terms
Self-serving content
Causal assertive self-serving bias	(Relative) tendency to explain positive effects more from internal than external antecedents
Causal defensive self-serving bias	(Relative) tendency to explain negative effects more from external than internal antecedents
Enhancement	The framing of a positive outcome relative to negative external factors, e.g. The company achieved strong revenue growth in the Orange division, despite an industry-wide decline in demand for goods produced
Entitlement	Positive effects causally attributed to internal factors (e.g. management decision) rather than external factors (e.g. industry or economy wide factors)
Excuse	Negative effects causally attributed to external factors (e.g. industry or economy wide factors) rather than internal factors (e.g. management decision), e.g. Sales declined in the period, largely due to poor demand reflecting an unexpected downturn in the economic cycle
Justification	Teleological explanations of negative effects, e.g. R&D expenses increased in order to accelerate the introduction of new high-quality products
Causality denial	Implicit denial of responsibility for a negative effect by referring to internal proactive or remedial factors, e.g. Despite increased efforts of sales staff, sales declined in the period
Inconsistency of explanations
Formality inconsistency on valence of effects	Relative use of accounting-technical explanations for positive versus negative effects
Depth inconsistency on valence of effects	Number of explanations per effect for positive versus negative effects

Appendix 2

Aerts and Tarca (2010) Coding dimensions of attribution statements

An attribution statement: One or more sentences (or part thereof) in which an outcome or effect (relating to a firm’s financial performance, i.e. revenue, expense or net income/earnings/profit item) is linked to one or more antecedents for that outcome. Each attribution statement was coded on dimensions A01–A05 for the outcome/effect phrase and B10–B15 for each antecedent phrase.

A. Outcome/effect	B. Antecedent
A01 Nature of the effect	B10 Explicitness of the antecedent-consequence relationship
Revenue	1. Explicit
1. Expenses	2. Implicit
2. Income/earnings/profit	3. Decomposition (effect = sales, cause = sales)
A02 Valence of the effect	B11 Direction of antecedent-consequence relationship
1. Positive (e.g. increase sales, decrease expenses)	1. Same direction
2. Negative (e.g. decrease sales, increase expenses)	2. Opposite direction
3. Unchanged/flat	B12 Time orientation of antecedent
A03 Time orientation of the effect	1. Past (effect concerns event of preceding fiscal year)
1. Past (effect concerns event of preceding fiscal year)	2. Present (year under review)
2. Present (year under review)	3. Future
3. Future	B13 Antecedent is expressed in quantitative or qualitative terms
A04 Effect is expressed in quantitative or qualitative terms	1. Quantitative
1. Quantitative	2. Qualitative
2. Qualitative	B14 Nature of explanation
A05 Level of the explained effect	1. Causal explanation
1. Division/product/geographic segment	2. Accounting-technical explanation
2. Company as a whole	B15 Locus of causality of antecedent
	1. Internal cause, explicit reference to management board
	2. Internal cause, explicit reference to segment division in the company
	3. Internal cause with explicit reference to personnel
	4. Other internal causes
	5. External cause; cause is on sector or industry level
	6. External cause; cause is on general economic level
	7. Other external causes

Appendix 3

Aerts and Tarca (2010) Examples of attribution statements

• 1. Antecedent-consequence relationship: an expense outcome is linked to two explanations, one coded as technical-accounting and the other as causal:

The cost of merchandise sold decreased in 2003 compared to 2002 [effect] reflecting lower spending on goods and services due to lower sales [antecedent (a) technical-accounting] as well as favourable procurement conditions [antecedent (b) causal].

Sears Canada Inc. 2003 Annual Report p. 28 (Canada Retail)

• 2. Explicit explanations: characterised by a causal conjunction or connecting phrase (e.g. because of, as a result of) and the verb in the sentence can refer to an explicit explanation (e.g. lead to, result in). For example, consider the following positive outcome with an internal cause which uses ‘through’ as the causal conjunction:

Foreign exchange losses decreased in the year [effect] through better management of the consolidated entity affairs [antecedent—causal].

Peptech 2003 Annual Report p. 18 (Australia Biotech)

• 3. Implicit explanation: when cause and effect are not explicitly related. These implicit explanations are only taken into account when cause and effect can be reasonably linked to each other. In the following causal explanations (an excuse and an entitlement) cause and effect are linked by the words ‘as a result of’:

The company’s hog production operations were negatively impacted in 2003 as a result of the sharp rise in the Canadian dollar [antecedent—causal] which immediately reduced producer revenues [effect].

Maple Leaf Foods, 2003 p. 29 (Canadian Food producer).

We are continuing to realise gains in our primary margin [effect] as a result of actions to increase overseas production and consolidate our supply base [antecedent—causal].

Marks and Spencer, 2003 p. 3 (UK Retail)

• 4. Time orientation: as shown below in a prospective causal statement:

The outsourcing of the liquid sorbitol production at Atlas Point was completed this year [antecedent—causal]. These changes are expected to yield a profit improvement next year [effect].

Associated British Foods, 2003, p. 20 (UK Food producer).

• 5. Technical-accounting attributions: explanations of accounting effects in financial accounting language:

During fiscal 2003 … lower depreciation expense [antecedent: internal—technical-accounting] contributed to improvement in gross profit and margin [effect].

Other income increased to $3,350,000 in 2003 from $2,285,000 in 2002 [effect] primarily as a result of $932,000 improvement in equity in net earning of affiliates [antecedent: internal—technical-accounting].

Florida Rock Industries Inc., 2003 pp. 8–9 (US Building Materials)