Rob Swystun, Pristine Advisers
It turns out that companies that try to spin their earnings calls tend to perform more poorly than companies that don’t.
How do they spin their earnings calls?
They “choreograph” the calls so that they only end up taking questions from analysts who are favorable to them.
However, as pointed out by CFO Magazine’s Alissa Ponchione, a new working paper by professors at Harvard University and the London School of Economics and Political Science says that companies that do this tend to be hiding negative information and also tend to underperform during future quarters.
The working paper is entitled “Playing Favorites: How Firms Prevent the Revelation of Bad News” and the researchers found that the practice of only taking questions from friendly analysts that have been set up by the companies often leads to drops in future earnings. Furthermore, companies that manipulate their earnings calls like this often have higher accruals, are barely meeting earnings forecasts and insider trading will typically rise dramatically at these places in the quarter following a staged earnings call.
For the study, researchers analyzed transcripts from every conference call of publicly traded companies in the US between 2003 and 2011. They were able to see not only which analysts the companies selected during the call, but also how favorable and accurate the analysts’ past recommendations were.
Sealed Air Corporation, a packaging material company in New Jersey, had a first-quarter earnings call in April of 2007 that had eleven analysts covering it. But the company only took questions from analysts that had given high recommendations on Sealed Air’s stock leading up to the call. The report stated that the analysts complimented the firm and joked with the CEO, but did not challenge him on the upcoming quarter.
At the second earnings call that year, three months later, the company missed expectations and had its first negative cash-flow quarter.
Now, there’s nothing actually illegal about calling on analysts that you know will only toss softballs for questions, Harvard Business School professor Lauren Cohen says, but “casting” calls like this is misleading to both analysts and investors.
Inviting questions from sell-side analysts while ignoring buy-side analysts generally means missing out on questions that would dig deeper into the data a company is presenting during the call. Not to mention that this behavior might just prompt some analysts to stop covering the company.
Cohen co-authored the report along with HBS professor Christopher Malloy and LSE professor Dong Lou.
This could take the form of analysts listing their recommendations prior to the call beginning so listeners will know if the person has a strong buy or sell recommendation on the stock. Simply listing the callers would also help companies be more transparent.
“It wouldn’t cost a firm or the SEC that much,” Cohen says. “It’s a pretty simple and low-cost solution.”
He also called on CFOs to be “more egalitarian in their calling patterns.”