Investor Reaction to Hypothetical Disclosures in Earnings Calls

We examine the implications of hypothetical disclosure in conference calls for firms' future financial performance and stock returns. Managers may use hypothetical disclosure in earnings calls to provide valuable forward-looking information regarding the firm's performance. Alternatively, managers may strategically use hypothetical disclosure to obfuscate and hide bad news about current and future financial performance. Applying natural language processing to the corpus of earning call transcripts, we create a firm-level measure that objectively quantifies the extent of hypothetical statements used by firms during the earnings calls. Consistent with obfuscation, we find that greater use of hypothetical statements is associated with a negative market reaction. The market reaction is statistically and economically significant and is half the economic magnitude of the reaction to standardized unexpected earnings surprise. Markets react slowly to such hypothetical disclosures. A greater hypothetical incidence also negatively predicts future returns for up to two months after disclosure, consistent with delayed price reaction. We also find that greater use of hypothetical statements is associated with lower future earnings and sales growth.