Textual Similarity of Firm Accounting Policy Disclosures Reginald - PowerPoint PPT Presentation

Textual Similarity of Firm Accounting Policy Disclosures Reginald Edwards, PhD April 2018

Sources of Accounting Information • Quarterly Financial Reports (10-Q’s) Ad-hoc disclosures (e.g. 8-K’s) • Annual Reports (10-K’s) • – MD&A – Footnotes to the Financial Statements • “Summary of Significant Accounting Policies”

TD Ameritrade (NASDQ: amtd) 2017 Annual Report Footnotes

TD Ameritrade (NASDQ: amtd) 2017 Annual Report Footnotes

The Textual Similarity of Accounting Policy Disclosures • For each firm-year, I extract the “Summary of Significant Accounting Policies” section from annual report • Compare text of industry peers using cosine similarity measure • More similar text yields higher textual similarity score, SIM • Compute SIM by comparing text of same firm in adjacent years for context

Measuring Textual Similarity of Accounting Policy Disclosures Apple Inc. and its wholly-owned subsidiaries Cosine similarity (collectively “Apple” or the “Company”) design, manufacture, and market personal computers, Documents as vectors of word counts • mobile communication devices, and portable digital music and video players and sell a variety of related Text reuse/plagiarism detection • software, third-party digital content and applications, services, peripherals, and networking Document clustering • solutions. (Apple 10-K, 2009) See Hoberg, Phillips, and Prabhala • Apple Inc. and its wholly-owned subsidiaries (2012) for a finance application (collectively “Apple” or the “Company”) designs, manufactures, and markets mobile communication and media devices, personal computers, and portable digital music players, and sells a variety of related software, services, peripherals, networking solutions, and third-party digital content and applications. (Apple 10-K, 2011)

Measuring Textual Similarity of Accounting Policy Disclosures 2009 and 2011 words [apple, applications, collectively, communication, computers, content, design, devices, digital, manufacture, market, media, …] 2009 word vector: (2, 1, 1, 1, 1, 1, 1, 1, 2, 1, 1, 0, …) 2011 word vector: (2, 1, 1, 1, 1, 1, 1, 1, 2, 1, 1, 1, …)

Measuring Textual Similarity of Accounting Policy Disclosures • 2009 = (2, 1, 1, 1, 1, 1, 1, 1, 2, 1, 1, 0, …) 2011 = (2, 1, 1, 1, 1, 1, 1, 1, 2, 1, 1, 1, …)

Measuring Textual Similarity SCHW .10 AMTD 0.2 0.8 SIM AMTD = 0.9 ETFC SIM SCHW = 0.5 SIM ETFC = 0.6

Properties of Textual Similarity of Accounting Policy Disclosures Percentile 1 st 5 th 25 th 50 th 75 th 95 th 99 th Mean Std Dev Peer firm similarity 0.74 0.07 0.48 0.62 0.71 0.72 0.79 0.82 0.83 Own-firm similarity 0.80 0.09 0.47 0.65 0.76 0.80 0.86 0.94 0.95

Validation WHAT IS THE INFORMATION CONTENT OF SIM ?

Textual Similarity of Accounting Policy Disclosures: Covariates •

Textual Similarity of Accounting Policy Disclosures and Earnings • What is the predictive power of SIM for earnings measures? • ROA (contemporaneous net income scaled by assets) • Future ROA • Future negative earnings indicator • Future earnings decline indicator

Textual Similarity of Accounting Policy Disclosures and Earnings What is the predictive power of SIM for earnings measures? • • ROA (contemporaneous net income scaled by assets) ➔ YES (pos.) • Future ROA ➔ NOT REALLY Future negative earnings indicator ➔ YES (neg.) • Future earnings decline indicator ➔ YES (neg.) •

Textual Similarity of Accounting Policy Disclosures and Earnings What is the predictive power of SIM for earnings measures? • • ROA (contemporaneous net income scaled by assets) ➔ YES (pos.) • Future ROA ➔ NOT REALLY Future negative earnings indicator ➔ YES (neg.) • Future earnings decline indicator ➔ YES (neg.) • ROA t ROA t+1 NEARN DEARN SIM 0.0047 -0.0218 -0.0400 -0.0930 (0.0024) (0.0146) (0.0066) (0.0076)