This study scrutinizes the influence of earnings management practices on the tone of the narrative board of directors' report of the annual report. Likewise, it investigates the effect of narrative reporting tone on stock liquidity. Besides, it explores how earnings management practices could affect the relationship between narrative reporting tone and stock liquidity.
The study utilizes a sample of Egyptian firms listed on the EGX 100 index from 2010 to 2023. It develops a new Python 3.6 script to measure the narrative reporting tone in Arabic annual reports. Earnings management is estimated with the widely used modified Jones model. Stock liquidity is proxied by the standard bid–ask spread.
The results reveal that Egyptian firms are likely to use more positive than negative tones in their narrative board of directors' reports. Likewise, the abnormal tone of the board of directors' report is a positive consequence of earnings management practices, indicating that entities with such practices tend to provide a net positive tone in their narrative reporting. Additionally, the net positive tone directly affects stock liquidity. However, earnings management practices reduce the direct interplay between the net positive tone and liquidity of the stock. The results suggest that Egyptian entities with earnings management practices exhibit higher information asymmetry and, consequently, lower stock liquidity.
While this study offers several contributions, it also faces some limitations. It focuses on Egyptian companies in the EGX 100 index, which could limit how broadly the findings generalize across settings or financial markets.
Regulators may consider implementing stricter regulations or providing more precise guidelines to mitigate the potential impact of earnings management on narrative reporting tone. Corporate investors also need to be aware of the potential bias in the tone and conduct thorough analyses to avoid being swayed solely by the positive language used in the reports.
Aside from developed economies, the study provides the first evidence of interactions between earnings management, narrative reporting tone and stock market liquidity in an emerging economy with unique institutional settings and reporting requirements (i.e. Egypt). Likewise, it advances methodological approaches for assessing the tone of narrative reporting of Arabic-written texts.
