The effect of qualitative expressions of magnitude in the letter to shareholders on investors' perceptions of earnings performance: Working paper series--03-18

Annual reports issued by publicly traded firms are important documents for communicating the financial performance of a company. In addition to the financial statements, annual reports contain non-numerical information (i.e., written expressions). The letter to shareholders is typically the first non-numerical item representing management's communication that a reader comes to in an annual report. The primary content of the letter to shareholders is a series of written expressions used to describe the company's financial situation. We report how readers' perceptions are influenced by one type of written expression often found in the letter to shareholders: Qualitative expressions of magnitude (e.g., "minimal," "moderate" or "sizable") used to describe the results of operations. Top management (e.g., presidents) very often uses qualitative expressions of magnitude in the letter to shareholders to describe the quantitative financial performance of the company found in the accompanying financial statements. Holding the actual percentage change in corporate earnings and other contextual factors constant, we find that the type of expression used in the letter to shareholders does influence readers' perception of financial performance reported in the financial statements. In addition, we find evidence that less sophisticated investors are influenced more by the use of qualitative expressions of magnitude