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Nov 18, 2019

IR papers: Airing your dirty laundry can irritate your investors

A roundup of academic research from the world of IR studies

Investors punish firms that voluntarily disclose the existence of an SEC fraud investigation – even more so when those firms are exonerated, according to a new study. Sampling around 600 investigations, researchers find disclosers underperform other non-sanctioned firms that stay silent by almost 7 percent in the two months following the announcement. The gap rises to 12.7 percent after one year. What’s more, CEOs at disclosing firms are nearly 14 percent more likely to be fired within two years than their more taciturn peers.

‘A lot of academic research points to transparency being rewarded,’ says study co-author David Solomon, assistant professor of finance at Boston College. ‘But in some cases, managers may not be reluctant enough when it comes to disclosing bad news.’

The study results show that the more prominent the disclosure, the worse the stock price impact. ‘Trying to get ahead of the story makes things worse, not better,’ notes Solomon. ‘That suggests our findings are at least partially driven by limited investor attention. I also suspect there’s a lasting reputational stigma. Investors believe something dodgy must be going on [following regulatory attention].’ He calls for regulators to either mandate universal disclosure or clearly rule that no legal sanction will follow from non-disclosure.

Why you should be a vice president

Companies with IR executives in the top management team are more likely to achieve earnings targets than those without, according to a comprehensive new study. These firms regularly beat analyst estimates by managing expectations, not earnings. They are also more likely to have lower analyst forecast dispersion, a lower probability of informed trading and fewer earnings restatements. And they enjoy better access to external financing and lower litigation risk.

‘The job title perhaps matters less than proximity to top corporate decision-makers,’ notes study co-author Shawn Mobbs, associate professor of finance at the University of Alabama. ‘But firms that value the IR role produce a variety of positive [capital markets] outcomes.’

Seduce investors with ‘warm-glow’ rhetoric

Scientists have long known that a CEO’s vocal tone during conference calls can temper investors’ negative reactions to earnings surprises. ‘Optimism’ and ‘certainty’, for example, are rewarded. Now researchers are exploring other oratorical tactics. One, known as ‘warm-glow’ rhetoric, has proven especially effective.

‘Warm-glow theory suggests individuals are willing to make suboptimal economic choices when they get [alternative] payoffs – ones that make them feel good about themselves,’ explains Vivien Jancenelle, assistant professor of management at Texas A&M UniversityCentral Texas. ‘Politicians often use it to gain voter support, especially in times of controversy.’

Sampling almost 2,000 earnings calls, Jancenelle’s research team finds CEOs who induce warm-glow feelings significantly enhance financial performance, as measured by cumulative abnormal returns.

Analysts’ selective disclosure strategy

As intermediaries, financial analysts serve multiple masters. Regarding earnings forecasts, their corporate clients want ‘beatable’, while investors seek accuracy. Now we know how analysts manage these conflicting demands: new research shows they revise current earnings more often for bad news than for good.

‘By accentuating the negative, analysts please top executives at the firms they cover,’ says study co-author Zachary Kaplan, assistant professor of accounting at Washington University. Good news gets out via channels such as stock price targets or simple expressions of optimism – typically available only to brokerage clients.

‘The downward pressure from corporates [on earnings forecasts] is very effective, but widely circulated earnings forecasts aren’t necessarily as informative as many people think,’ Kaplan concludes.

This article was published in the Winter 2019 issue of IR Magazine.