Do letters to shareholders inform or mislead? Insights from insider trading

Empirical studies consistently provide evidence that investors perceive qualitative disclosures as useful because they have significant effects on analysts’ forecast
revisions and a firm’s share price. But these results leave unanswered the question
of whether managers write qualitative disclosures to inform or mislead investors.
Based on the signaling theory, we consider two actions by the same manager: one
(insider trading) is a costly signal whilst the other (qualitative disclosure) is the cheap
signal. We then verify whether they are coherent. We investigate the content and the
verbal tone of the Letter of Shareholders and the insider trading from its author before and after the letter’s date of release and find that the costly signal (the insider
trading) is not coherent with the cheap signal (the disclosure). This finding indicates
that managers do not use qualitative disclosures to offer incremental information but
that they might use them to mislead investors.