On the Correspondence Between Management's Discussion and Analysis and the Face of the Financial Statements

We develop a theory and a text-analytic method to model managers’ translation of economic activity into the preparation of Management’s Discussion and Analysis (MD&A). Our approach considers both quantitative and qualitative accounting information by linking numerical changes in the financial statements with year-over-year textual modifications to the MD&A. We use our method to construct a measure of the expected disclosure, given firms’ underlying economics as captured by changes in the financial statements. Next, we examine deviations from this expectation to examine how the market incorporates different aspects of disclosures into stock prices. We theorize and document that the edit patterns of MD&A modifications and their connection to the financial statements convey different signals about firm value. While the market often correctly interprets the sign of those signals, we show that the immediate response is severely incomplete, providing a more nuanced view of the breakdown in communication between managers and investors