Corporate managers may employ a variety of tools to reduce the share price effect of bad news. During disappointing quarterly earnings calls, one popular tactic is the liberal use of forward-looking qualitative disclosures such as: ‘We believe our year-over-year revenue growth will accelerate.’
Now a new study shows investors see through this kind of obfuscation – but only gradually. An analysis of the prepared remarks section of more than 60,000 US earnings call transcripts reveals a strong correlation between high levels of hypothetical disclosure and the intensity of negative investor reaction.
‘Markets perceive a greater use of hypotheticals – especially by value-oriented firms – as a negative signal about future performance,’ concludes study co-author Shashwat Alok, assistant professor of finance at the Indian School of Business. ‘Investors react immediately but it takes about three months for stock prices to fully reflect this signal’s negative implications. Given the delayed price reaction, managers are at least partially successful in their goal of obfuscation.’
Alok notes investors’ reaction is rational: ‘Our analysis shows firms that use more hypotheticals in earnings calls go on to report deteriorating fundamental performance.’
Trust in numbers
Managers have discretion over whether to quantify their earnings guidance and the explanations for it. But a new pre-print study suggests quantifying supplementary disclosures – as suggested by regulators and demanded by investors – may not always produce positive reactions.
Using an experimental approach, an international team of investigators shows quantitative attributions play a positive role compared with the qualitative kind in influencing investor judgments – but only when they supplement qualitative earnings guidance. In contrast, when guidance is quantitative, quantifying an attribution elicits investor questioning, which reduces valuation judgments.
Study authors write: ‘If managers decide to provide quantitative guidance, it would be beneficial to provide a qualitative attribution to explain the specific earnings projections. Those managers who intend to increase the persuasiveness of quantitative guidance by quantifying attributions may not find this strategy effective; it could even backfire.’
Walking the walk
In the wake of numerous scandals, top executives are increasingly seeking to portray their organization as ethical. But new research reveals corporate communicators should be wary of using ‘virtue rhetoric’, especially if they aren’t prepared to back it up with concrete actions.
Sampling unethical events caused by S&P 500 firms combined with analysis of their annual shareholder letters, researchers find investor reaction to ethics violations is up to four times more negative for companies that claimed to be virtuous prior to the violation than for those that did not make such claims.
‘Some argue that touting values establishes a company as ethical, so retribution for bad behavior might be less severe because investors could assume the behavior is a temporary glitch,’ says study co-author Miles Zachary, associate professor of management at Auburn University. ‘But our research shows that a disconnect between actions and words is likely to cast doubt on everything the firm has said about itself and only serves to intensify investor disapproval.’
Still, if a company’s performance outlook is good, investors seem willing to disregard bad behavior. ‘In this case, managers can essentially ignore the risk of communicating the firm’s values,’ Zachary adds. ‘On the other hand, if perceived future value is low, managers should signal the firm’s ethics only if they truly believe unethical behavior is unlikely to occur.’
The 7 percent solution
Unit firms that don’t conduct a pre-spinoff roadshow experience an average 7 percent drop in institutional ownership after the split, according to new research. In contrast, companies that do initiate a communications plan see the level of inherited institutional ownership remain unchanged.
‘An important benefit of communication is that these firms avoid the stock price pressure commonly experienced by unit firms following a sell-off,’ writes study author Ryan McDonough, assistant professor of accounting at Rutgers Business School.
