IR Papers: Don’t communicate – surprise the market

Dec 21, 2010
<p>A roundup of academic research from the world of IR studies</p>

Why do extreme positive earnings surprises occur? Sometimes you can chalk it up to analyst inattention; sometimes, it seems, managers create the earnings surprise to attract that attention. Indeed, recent research shows companies can get a significant increase in analyst coverage, trading volume and percentage of shares held by institutions following huge positive earnings surprises.

Investigators at the University of Washington and the University of British Columbia admit they cannot know managers’ intentions. But they discovered three clues that ‘point to the possibility that the large earnings surprise was intentionally created to attract investor attention.’ These surprises tend to be seen in ‘neglected’ firms whose managers expect strong future earnings performance and who are less likely to provide guidance.  

‘Any distribution will have a tail of extreme outliers, and people once thought these sorts of surprises were just random occurrences,’ says Mark Soliman, associate professor of accounting at the University of Washington. ‘But our research shows there is something else going on besides random distribution.’

Soliman cautions any company considering this effective attention-grabbing technique to do it based on a consistent and fundamental shift in its business prospects. ‘If you are going to have a big surprise, you had better show performance moving forward,’ concludes Soliman. ‘You don’t want to have everyone looking at you and then fall flat on your face.’

Undiscovered country
Brazil has seen exponential growth in IR following a torrent of IPOs between 2004 and 2007. While communications technique and technology have rapidly advanced, however, shareholder monitoring and targeting tools remain largely undeveloped.

‘Most Brazilian companies either don’t [use technology to] manage their shareholder base at all or use simple spreadsheets adapted for the purpose,’ says Vinicio de Souza e Almeida, professor of finance at the Federal University of Rio Grande do Norte. ‘This is a new and concerning issue for Brazilian IR. Proper shareholder base management can limit volatility while increasing liquidity and market capitalization.’

Almeida’s survey of 21 IR managers reveals a hunger for better software but complaints that few products are designed for the Brazilian market. ‘There’s plenty of room for international companies to market software in Brazil,’ he notes.  

Dial for dollars
Companies with the urge to merge are leaving money on the table if they don’t accompany the merger announcement with a conference call, according to a recent study. Sampling more than 1,200 transactions, US researchers find a strong association between conference calls and positive market reaction to merger announcements. ‘Conference calls are especially important for gaining market confidence if the transaction uses stock as currency,’ says study co-author Michael Kimbrough, associate professor of accounting at the University of Maryland.

Curiously, Kimbrough finds only 62 percent of merger deals are accompanied by conference calls. One reason, he notes, is that conference calls are a risky form of disclosure. ‘How management teams weather scrutiny during the Q&A is critical,’ he says. ‘If they can’t speak authoritatively and with sufficient detail about the assumptions that underlie the deal, the conference call will backfire.’

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