Corporate diversification and 10-K narratives: A novel approach using large language models

We examine the impact of corporate diversification on the narrative characteristics of firms’ 10-K filings. Using a novel measure based on a pretrained large language model, we find that diversification significantly reduces the readability of 10-K filings. This reduction in readability is not driven by the inherent complexity associated with diversification but might be due to managerial obfuscation. Our cross-sectional analysis reveals that the effect is more pronounced for firms with poor internal controls, limited external monitoring, and poor audit quality. We also find that diversification is associated with a significantly less negative tone in the 10-K filings, suggesting that managers might use a neutral or less pessimistic tone to offset investor concerns about firm performance. Prior research has focused on the impact of diversification on financial performance, risk, and investment policies, however, our study is among the first to examine how diversification shapes managerial communication with external stakeholders.