How to spot corporate spin in earnings announcements
Beware blame on external factors, bad news buried on Fridays and deceptive graph use
World Trade Center on the day of the 9/11 attacks: Labour adviser Jo Moore famously suggested it was a good day for the British government to bury bad news. Photograph: Sean Adair/Reuters
US earnings season is winding down. Individual share prices lurch up and down as investors and analysts pore over the details in an effort to divine how companies are performing, but it’s not an easy job. Companies like to put a positive spin on things. Here are a few subtle – and not so subtle – tricks employed by PR-conscious companies.
Order of information
Managers have some discretion in how they prepare earnings announcements, and they can use this discretion in ways that can influence even the savviest of investors.
In the past, for example, some companies gave more prominence to accounting measures that presented their finances in a favourable light, relegating discussion of GAAP (generally accepted accounting principles) earnings until later in the earnings release. That practice has since been outlawed, but there are other ways companies can take advantage of investors’ limited attention spans.
A recent study found investors are influenced by the order of information in earnings press releases, with positive information tending to be concentrated in the first section of press releases. Market reactions are more positive when positive information is presented more prominently, the study found, even after controlling for the extent of the earnings surprise.
However, another recent study suggests companies should be similarly conscious as to how they end their earnings reports. In an experiment, ordinary investors were asked to read an earnings report about a fictitious company. Participants were more inclined to invest in the fictitious company when the report ended on a positive note; over 60 per cent were less inclined to invest when negative information was presented at the end.
Financial information is often regarded as “objective, neutral and value-free”, but that’s not really the case, said the authors, who say companies might benefit by hiding negative information in the middle of a report and disclosing positive information at the end.
Graphs grab people’s attention and their message can be quickly imprinted and retained in the memory. Unsurprisingly, then, companies are much more likely to use graphs highlighting positive rather than negative information. One 2011 study found “clear evidence of impression management in graph usage”, with an “overwhelming portrayal of good rather than bad news”. This was especially true of high-impact industries, such as mining.
It’s also true of banks, according to a study published in the Journal of Applied Accounting Research earlier this year, with riskier European banks less likely to use graphs depicting credit risks.
“Banks, especially those with a high credit risk, are likely to be subject to high levels of public scrutiny,” the authors noted. Providing inaccurate information could cause a public outcry, but a policy of “selective omission” is less likely to inflame opinion.
Readers of financial reports “need to be careful about subtle forms of impression management”, it cautioned.
All of us like to take the credit when things work out well and to blame others when things don’t work out quite so well. Companies are no different and research has shown executives are more likely to take credit for good results and to discuss external factors when the news is negative.
Furthermore, when comparing results to prior periods, managers are more likely to focus on a previous quarter that makes today’s results look especially strong. It’s human nature, really, to behave this way. Success has many parents, to use an old saying, but failure is an orphan.
However, experimental research suggests investors are not impressed by this approach. In one study, Mea Culpa: Predicting Stock Prices from Organizational Attributions, researchers asked participants to read about a fictitious company that had performed poorly over the previous year. One group read an annual report that blamed external factors that were “completely outside our control”; the second group read a report where the company took responsibility, saying the drop in earnings was mainly driven by poor strategic decisions taken over the previous year. Participants had “significantly more favourable” impressions of companies that blamed internal rather than external factors, the study found.
Markets appear to share this preference. The same researchers found companies that made “self-disserving” as opposed to self-serving statements in their reports had higher stock prices one year later. Companies that attribute earnings problems to internal mistakes make it appear they have greater control and a plan to correct the problem, the authors concluded. Ironically, self-serving statements can ultimately be self-disserving.
Bury bad news
On the day of the 9/11 attacks in 2001, Labour adviser Jo Moore famously suggested it was a very good day for the British government to bury bad news. Companies have long adopted a similar approach, releasing bad news when they think investors and journalists are least likely to be paying attention.
A 2004 study found companies were much more likely to release bad earnings on a Friday, with Friday announcements about 50 per cent more likely to miss analyst expectations. The strategy worked for a while – the initial market reaction tended to be much more muted than on other days, the study found, as investors switched off for the weekend – but only for a while, with the bad news gradually becoming reflected in the company’s share price.
More recent research confirms companies continue to play this game. A 2014 Stanford study, for example, found that earnings reported after trading hours, on busy days and on Fridays tend to be much worse than at other times.
The Friday trick no longer works. It’s now so well-known that the share price tends to fall as soon as a company schedules a Friday earnings announcement.
However, companies are right to think markets can get temporarily distracted. After the market closes and on busy days when many companies are filing results, there is a sharp fall in the number of related news articles published; related Google searches decline; analysts are slower to update forecasts; and the number of downloads from regulatory databases plunges. It all suggests managers try to hide bad news by announcing it in periods of low attention, the researchers suggest.
Not only that, companies with very good news to report are more likely to reschedule to days where there is higher attention, they add.
Still, such shenanigans only have, at best, a short-lived impact on the share price, with bad news soon baked into market prices. So why do it? A sudden share price drop is much more likely to attract negative media coverage than a gradual decline, and these articles now live forever on the internet.
Chief executives have their own career and reputational concerns, the authors note, with various studies suggesting favourable media coverage is linked to higher pay and better career outcomes. In other words, attempts to bury bad news are not going to boost company share prices for any period of time, but they won’t do managers’ career prospects any harm at all.