Using MD&A to Improve Earnings Forecasts

In this article, we combine narrative disclosures in the Management Discussion and Analysis (MD&A) Section of 10-K reports with financial variables to generate explicit firm-level forecasts of 1-year-ahead return on equity (ROE). Testing our forecasts out-of-sample, we find that models enhanced with MD&A disclosures are more accurate than models using quantitative financial variables alone. We also find that text-enhanced models are as good as or better than analyst consensus forecasts for small firms and firms with low analyst following. We provide evidence on the informativeness of the MD&A section across different firm characteristics. We find that firms with large changes in future performance, negative future performance, high investor scrutiny, high distress risk, high positive accruals, and high value relevance of earnings have more informative MD&A disclosures, whereas younger firms and firms facing greater market risk and litigation exposure have less informative MD&As. Our results are robust to alternative empirical choices regarding benchmarks and specifications. Overall, our inferences are consistent with MD&A disclosures positively contributing to firms’ information environments.