Bankruptcy in the UK: Do Managers Talk the Talk Before Walking the Walk?

Abstract

This study examines whether managers employ annual report textual disclosures as a conduit to communicate the probability of future corporate bankruptcy or to intentionally mislead stakeholders owing to impression management incentives. We conduct various examinations around the information content of the tone conveyed by textual disclosures in unstructured UK annual reports and the probability of corporate bankruptcy. We document that firms that communicate a more net positive tone are associated with lower bankruptcy risk. Importantly, this association is found to be stronger for firms whose managers have a lower incentive to mislead investors owing to better board monitoring, stringent stock market regulation, and Big 4 audits. We also offer complementary evidence that firms conveying a more net positive tone exhibit higher future performance and earnings persistence, and lower future performance volatility. These firms are also less likely to exhibit extreme corporate policies and to receive a qualified auditor's opinion. Overall, this study sheds light on whether managers tend to inform or misinform (bury their heads in the sand) about corporate bankruptcy.