Qualitative Management Disclosures and Market Sentiment

We construct an index of aggregate management optimism from managers' qualitative disclosures in annual and quarterly financial reports and show that this index varies with market-wide sentiment. First, we find that the correlation between the management optimism index and Baker and Wurgler's investment sentiment index is 0.617, and investor sentiment explains 37.7% of the time-series variation in management optimism. Second, we find that when managers are more optimistic as a group, future earnings and stock returns are lower (at both the aggregate and the firm level). We show that these results are not driven by management opportunism. Instead, the results indicate that managers, like investors, are subject to market-wide sentiment. The resulting bias reduces the usefulness of management's qualitative disclosures.