Social trust and corporate qualitative disclosure: evidence from tone management in MD&A

ABSTRACT

Our study explores the association between province-level social trust and tone management in Management’s Discussion and Analysis (MD&A). We argue that a firm’s regional social trust is negatively associated with tone management because it creates norms and networks to discipline managers’ opportunistic behaviors. By exploring Chinese listed firms, we find that firms in provinces with higher social trust engage in less tone management. Our finding suggests that social trust serves as a mechanism to constrain tone management. While prior studies find that social trust disciplines quantitative disclosure, such as accounting numbers, our study suggests that this disciplining effect also applies to qualitative disclosure.

KEYWORDS:

• Social trust
• tone management
• disclosure

Acknowledgement:

We thank Carol Tilt (the Editor), Zhongwei Huang (the Associate Editor), and two anonymous reviewers for their helpful comments. We appreciate the financial supports from the Soft Science Foundation of Shandong Province (2022RKY07014) and the China Postdoctoral Science Foundation (2022M720515) for this study.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Social trust is crucial as it restrains opportunistic behaviors (Williamson, 1993), and the development of market economies relies on departing from closed group interactions and enlarging exchanges to anonymous (Algan & Cahuc, 2010). Hence, generalized trust is fundamental to transactions. This idea has a long tradition in the political science and economic literature (e.g., Banfield, 1958; Gambetta, 1988; Greif, 1993; Putnam et al., 1993; Coleman, 1994; Fukuyama, 1995; Knack & Keefer, 1997; La Porta et al., 1997; Putnam, 2000).

2 Practitioners well recognize the influence of trust on business ethics. For example, following the misconduct by Solomon Brothers in 1991, Warren Buffet said, “Trust is like the air we breathe. When it’s present, nobody really notices. But when it’s absent, everybody notices” (Sandlund, 2002). Moreover, business leaders generally agree “trusted leadership is more important now than ever before” (Galford & Drapeau, 2003).

3 We explore MD&A because it comprehensively discusses a firm’s overall conditions and is informative about firm fundamentals (Feldman et al., 2010), making it a target for manipulation (Li, 2008). Moreover, the issuance of MD&A is mandatory in China, alleviating the self-selection bias owing to the voluntary disclosure choice.

4 We thank an anonymous referee for providing this insightful argument.

5 Fukuyama (1997) suggested that in a vigorous network, there are many repeated games where people rely on each other. This reliance develops mutual trust that encourages honoring obligations, preventing people from abusing the trust of others to pursue personal gains.

6 We use unsigned residuals because managers are incentivized to manipulate tone downward in addition to upward manipulation. For example, previous studies show managers strategically disclose bad news before stock option grants to reduce the stock price to ensure a lower option strike price at the grant date (e.g., Aboody & Kasznik, 2000; McAnally et al., 2008). Huang et al. (2014) also find that managers bias investor perceptions downward using tone management in the earnings press release before an option grant.

7 The marketization index is developed by Fan and Wang (2016). It is a proxy for the quality of province-level institutions that facilitate market development, and provinces with higher scores on this index are expected to have more developed local financial markets. This index is constructed along several dimensions, including the relationship between the government and the market, the developments of the non-state sector, the factor markets, the product markets, and market intermediaries.

8 We include INCOME, EDUCATION, and RELIGIOSITY because people in regions with high social trust may be wealthy and well-educated or have sincere religious beliefs, while these features could affect regional norms and networks. We control for LNPOP and POPDEN because networks may be more important in regions with a denser population. We include ETHNIC because ethnic diversity hinders the formation of trust in society.

9 Because both DIVERSITY and DIALECT are associated with language diversity, they may capture the same effects. So, we do not regard them as two different instruments and include them simultaneously in the first stage of the instrumental regressions. However, when we include them concurrently in the first stage regression, we find that the Sargon statistic of the over-identification test is 0.2138 (p-value = 0.6438), supporting the exogeneity of these two instruments.

10 By employing the same plausible exogeneity test for DIALECT, we find that the 95% confidence interval for the impact of TRUST is [−12.103, 12.257] under the assumption that DIALECT takes values from the support of its two standard deviations [−0.5266, 0.5266]. Our conclusion is the same if the two instruments take values from the support of their one or three standard deviations.

11 Besides omitted variables, endogeneity may arise from reverse causality. Although tone management is unlikely to determine social trust levels, we mitigate this concern using lagged TRUST. Untabulated results show that this does not alter our inference.

12 Specifically, for each firm, we regress its daily stock returns on the market returns over the period (-60, – 30). We then multiply the regression coefficient (i.e., the beta coefficient) with the market return on the event date to estimate the predicted return, where the abnormal return on the event date is calculated as the raw return minus the predicted return.

Additional information

Funding

This work was supported by Soft Science Foundation of Shandong Province: [Grant Number 2022RKY07014]; China Postdoctoral Science Foundation: [Grant Number 2022M720515].