The Concept Release in SEC (1987)” encouraged performance explanations after recognising that at the time, narratives were substandard. A follow up in SEC (1989) emphasised that material performance changes ought to be explained by providing information that is incremental to financial statements and footnotes for the benefit of investors. Pursuant to this, Bryan (1997) investigated whether explanatory information in financial reports narratives of firms was useful to investors. Among the attributes investigated were reasons for both
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revenue and cost changes in 250 MD&As for the year 1990. The insignificant results were thought to have been influenced by prior release of such information in announcements preceding the annual report. In Finland, Schadewitz et al (2002) thoroughly read 573 interim reports of firms listed on the Helsinki Exchange and established that troubled firms were characterised by disclosing more information beyond expectations. However, market reacted negatively to such information suggesting that an endeavour to provide excessive explanatory analysis of bad performance does not pay off. Further, although investors may well be aware of the bad state of affairs through previous announcements, they wait until publication of the financial reports to confirm their suspicions and thereby react negatively on receiving the annual reports. This finding is contrary to, Bryan (1997) who suggests that prior announcements make explanatory attributions in financial reports defunct. In Schleicher, et al (2007), it was posited and confirmed in the results that in a loss making circumstances, investors do not envisage that loss making does not prevail indefinitely for ongoing firms.
Since the current performance (losses) is not a good guide for the future performance potential, investors require an explanation to the losses and an assurance of future viability.
For profit making firms, however, the good financial performance is evidence for the feasibility of the business; hence, further disclosures may not be relevant for the purpose.
Further evidence on the usefulness of the causation attribution in Hutton et al (2003) suggests that managers enhance the credibility of earnings forecasts by providing further explanatory notes. Such information may be qualitative or quantitative. By classifying forecasts into good or bad news, their findings showed that the tendency to provide more quantitative (verifiable) explanations to good news forecasts enabled positive market reaction. In contrast, qualitative (non-verifiable) explanation, including factors such as macro economic, industry level, firm-specific, long/ short-term prospects and segmental information accompanying bad news forecasts had no impact to share returns because they are vague. Conversely, Lee et al (2004) argue that investors find causal statements for bad news credible especially if bad performance is blamed on internalities since this action shows management‟s awareness of internal weaknesses and willingness to correct the situation. However, in spite of the reliability investors attach to pessimistic disclosures, business managers tend to exercise bias when
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explaining performance. Bad attributions are blamed on externalities but good performance on internal activities. The findings, based on a manually scored Likert scale annual report disclosures, found bad news causal attributions useful but good news explanations were not possibly due to impression management. A comparable argument and finding is echoed in Abrahamson and Amir (1996) concerning relevance of disclosures in the president‟s letter in annual reports. Similarly, in Staw et al (1983) management was presumed to have a defensive and self-enhancing attitude when explaining performance with intent to influence share returns and other managerial rewards. In order to appease societal demands or expectations, self-justification is achieved through labelling poor performance causes as external factors, threats or uncertainties but good performance as internal strengths, opportunities to implicate any result (good or bad) as a rational response by management.
Attributing bad outcomes to external factors but taking credit for good results infers that management pursues only value increasing activities and are only setback by externalities beyond their control. This behaviour is conceptualised to result from day-to-day external reporting systems designed to foster a systematic, formal, consistent and sieved information flow that legitimises organisational actions rather than pursue optimal performance.
Correlation results in Staw et al (1983) between the self-enhancing explanations (for good news) as well as defensive explanations (for bad news) with share price changes confirmed both information is considered credible and useful to shareholders.
Alike Lee et al (2004) and Staw et al (1983), the reasoning behind explaining earnings forecast in Baginski et al (2004) is based on agency. Managers will link expected performance on internal actions or third party actions depending on the perceived investor image desired. Good forecasts will be attributed to inward activities whilst bad forecasts to external attributions. In respect to investors‟ opinion on causal disclosures, results based on a keyword search from 951 forecasts showed that the relationship with returns was predictable.
In addition, disclosures of causal attributions were established to be influenced by a set of variables that proxy for cost and benefit where more narratives were provided for large firms, more regulated industries, bad news but less for longer-term forecasts. In an earlier study, Baginski et al. (2000), the provision of more voluntary causal attributions for bad forecasts but
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less for good news portrays management‟s fear for litigation against withholding information.
Both Baginski et al (2004) and Baginski et al. (2000) argued that good (bad) news was attributed to internal (external) causes with an aim of maintaining investor confidence.
Although an impression management character is in inherent in the causal attributions, 3-day market returns were significantly influenced by the disclosures. This result was assumed to indicate that shareholders find the information credible.
Warner et al (1988) perceived the importance for the causal attribution in disclosures relating to management changes from the intrinsic value investors draw from the reasons provided.
Shareholders expect that management is well positioned to deliver good performance after a change and this opinion is confirmed from the reasons attached to the changes. For example, forced departures may implicate poor performance whilst a new recruit may be explained as a positioning strategy for future opportunities.
In conclusion, the provision of reasons for performance are largely informative to share price returns because they provide more information illuminating the circumstances in which performance was or will be achieved. However, the voluntary nature and impracticality of verifying the disclosures presents a prospect for misuse by managers to egoistically tone the information for impression management. It is thus prevalent for studies (e.g. Baginski et al.
2000; Baginski et al. 2004; Lee et al. 2004; Staw et al. 1983) to conjecture that internal outcomes are fond of explaining good news but external factors are reasons for poor performance. In addition, in some studies (e.g. Abrahamson and Amir 1996) investors are considered adequately enabled to distinguish noise from useful causal attribution disclosures.