The effect of operational activity volatility on earnings quality: A textual analysis

This study investigates the effect of operational activity volatility on earnings quality. By employing the Latent Dirichlet Allocation (LDA) model to capture companies’ operational activities from current reports, we find that operational activity volatility is associated with lower earnings quality. The results are robust to various tests. Mechanism analyses reveal that the volatility of operational activities affects both the motivation and the opportunity for earnings management, primarily by decreasing earnings persistence, increasing resource demand, intensifying performance pressure, and aggravating information asymmetry. Cross-sectional analyses show that our main findings are more pronounced for companies with higher market concentration, less analyst coverage, and those in the manufacturing industry. Economic consequence analyses reveal that the impact of operational activity volatility on earnings quality has significant implications for company value, capital market efficiency, and investor decisions. Our results highlight that textual differences in current reports can predict company earnings quality, offering new insights into the relationship between operational dynamics and financial reporting.