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Can Language Predict Bankruptcy? The Explanatory Power of Tone in 10‐K Filings

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  • Kerstin Lopatta
  • Mario Albert Gloger
  • Reemda Jaeschke

Abstract

We examine whether the language used in 10‐K filings reflects a firm's risk of bankruptcy. Our sample contains 424 bankrupt U.S. companies in the period 1994–2015 and we use propensity score matching to find healthy matches. Based on a logit model of failing and vital firms, our findings indicate that firms at risk of bankruptcy use significantly more negative words in their 10‐K filings than comparable vital companies. This relationship holds up until three years prior to the actual bankruptcy filing. With our investigation, we confirm the results from previous accounting and finance research. 10‐K filings contain valuable information beyond the reported financials. Additionally, we show that 10‐Ks filed in the year of a firm's collapse contain an increased number of litigious words relative to healthy businesses. This indicates that the management of failing firms is already dealing with legal issues when reporting financials prior to bankruptcy. Our results suggest that analysts ought to include the presentation of financials in their assessment of bankruptcy risk as it contains explanatory and predictive power beyond the financial ratios. Le langage employé permet‐il de prédire la faillite ? Le pouvoir explicatif du ton adopté dans les déclarations 10‐K Résumé Les auteurs se demandent si le langage utilisé dans les déclarations 10‐K révèle l'existence d'un risque de faillite de l'entreprise. Ils analysent un échantillon de 424 sociétés des États‐Unis ayant fait faillite entre 1994 et 2015 et utilisent l'appariement des coefficients de propension pour déterminer quelles sont les correspondances d'entreprises saines. En appliquant un modèle logit aux entreprises défaillantes et aux entreprises saines, ils constatent que celles qui présentent un risque de défaillance font un usage sensiblement plus abondant de termes négatifs dans leurs déclarations 10‐K que les entreprises saines comparables. Cette relation perdure jusqu’à trois ans avant le réel dépôt de bilan. L’étude confirme les résultats de travaux de recherche précédents en comptabilité et en finance. Les déclarations 10‐K contiennent de précieux renseignements au‐delà des données financières dont elles font état. De plus, les auteurs montrent que les déclarations 10‐K produites au cours de l'année de la débâcle d'une entreprise contiennent une quantité plus importante de termes litigieux par rapport à celles des entreprises saines. Cette observation révèle que la direction des entreprises défaillantes est déjà aux prises avec des problèmes d'ordre juridique lorsqu'elle produit les résultats financiers de la société avant la faillite. Ces constatations laissent croire que les analystes se doivent d'inclure la présentation des données financières dans leur évaluation du risque de défaillance, cette présentation ayant un pouvoir explicatif et prédictif qui s'ajoute à celui des ratios financiers.

Suggested Citation

  • Kerstin Lopatta & Mario Albert Gloger & Reemda Jaeschke, 2017. "Can Language Predict Bankruptcy? The Explanatory Power of Tone in 10‐K Filings," Accounting Perspectives, John Wiley & Sons, vol. 16(4), pages 315-343, December.
    • Handle: RePEc:wly:accper:v:16:y:2017:i:4:p:315-343
    DOI: 10.1111/1911-3838.12150
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