Tips and Tells from Managers: How Analysts And The Market Read Between The Lines Of Earnings Conference Calls via

Marina Druz

Swiss Finance Institute

Alexander F. Wagner

Swiss Finance Institute

Richard Zeckhauser

Harvard Kennedy School


Stock prices react significantly to the tone (negativity of words) managers use on earnings conference calls. This reaction reflects reasonably rational use of information. “Tone surprise” — the residual when negativity in managerial tone is regressed on the firm’s recent economic performance and CEO fixed effects — predicts future earnings and analyst uncertainty. Prices move more, as hypothesized, in firms where tone surprise predicts more strongly. Experienced analysts respond appropriately in revising their forecasts; inexperienced analysts overreact (underreact) to tone surprises in presentations (answers). Post-call price drift, like post-earnings announcement drift, suggests less-than-full-use of information embedded in managerial tone.

How Analysts And The Market Read Between The Lines Of Earnings Conference Calls – Introduction

How effectively can analysts and investors read “between the lines” of what managers say in earnings conference calls? This paper shows that these participants infer valuable information about future earnings and uncertainties, and react in a manner that moves the market in the appropriate direction. The analysis documents, in a more complete and direct manner than have prior studies, the link between managerial tone (primarily the degree of negativity in word choice), and company fundamentals, analyst responses, and stock price reactions.

It is well known and hardly surprising that market participants react strongly to news on concrete value-relevant information, such as earnings, that is contained in earnings press releases, as well as in documents such as 10-K filings and corporate annual reports. Interestingly, however, other aspects of the communication also matter. The market reacts to tone in 10-Ks (Loughran and McDonald (2011)), and tone in earnings press releases is also informative (Demers and Vega (2010) and Davis, Piger, and Sedor (2012)). Some studies show as well that the short-term stock market reaction reflects how – that is, using which linguistic tone and with which vocal cues – managers speak during the earnings conference call (Mayew and Venkatachalam 2012; Price, Doran, Peterson and Bliss 2012).

Why does the market react to the tone of corporate communications? Our overarching hypothesis is the:

RATIONAL REACTIONS HYPOTHESIS: Market participants rationally distill value-relevant information from tone over and above observables such as earnings.

To investigate this hypothesis, we structure our analysis around the basic idea that the value of a company is the sum of the expected future cash flows, discounted at rate r. If tone drives rational market reactions, it must predict expected future cash flows and/or influence uncertainty (which in turn would affect the discount rate).

We study earnings conference calls for S&P 500 companies from 2004 to 2012. We first document a variety of factors that lead managers to be negative: poor recent economic
performance by the company or the economy, and recent uncertainty. In addition, managers usually respond to analysts’ negativity in questions with negativity in answers.

Controlling for both the determinants of negativity and CEO fixed effects, we compute residual, “excessive” negativity, that is, the tone surprise. We posit that the managers’ choose words based on their total information. This includes much information that has already been disclosed or soon will be, but includes as well internal and non-quantifiable information that cannot be revealed in concrete fashion, for example, the managers’ expectations for the future. Managers might wish to reveal or conceal information of this latter type. Whether purposeful or inadvertent, tone surprise captures the negative elements in managers’ speech beyond what is justified by previous recorded performance. Our prime tests are whether tone surprise contains value-relevant information about the future, and whether the stock market recognizes this.

Earnings Conference Calls

Earnings Conference Calls

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