ABSTRACT We investigate whether and when firms manage the tone of words in earnings press releases, and how investors react to tone management. We estimate abnormal positive tone, ABTONE, as a measure of tone management from residuals of a tone model that controls for firm quantitative fundamentals such as performance, risk, and complexity. We find that ABTONE predicts negative future earnings and cash flows, is positively associated with upward perception management events, such as, just meeting/beating thresholds, future earnings restatements, SEO, and M&A, and is negatively associated with a downward perception management event, stock option grants. ABTONE has a positive stock return effect at the earnings announcement and a delayed negative reaction in the one and two quarters afterward. Balance sheet constrained firms and older firms are more likely to employ tone management over accruals management. Overall, the evidence is consistent with managers using strategic tone management to mislead investors about firm fundamentals.
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