A new study from the Harvard Kennedy School highlights that participants in earnings conference calls infer valuable information about future earnings and uncertainties based on the tone of the presenter as well as the information presented, and “react in a manner that moves the market in the appropriate direction.” This study builds on earlier studies to clearly establish a relationship between managerial tone (mainly the amount of negativity in word choice), and the financial performance of the firm in question, analyst responses and how the share price reacts after the conference call.
Earnings conference calls: More on new “managerial tone” study
Authors Marina Druz, Alexander F. Wagner and Richard Zeckhauser examined earnings conference calls for S&P 500 firms from 2004 to 2012. The first step was listing a variety of factors that lead managers to have a negative tone: weak recent economic performance by the company or the economy and recent uncertainty. Of note, executives “usually respond to analysts’ negativity in questions with negativity in answers.”
After controlling for both the determinants of negativity and CEO fixed effects, the researchers calculate “excessive” negativity, that is, the tone surprise. They hypothesize that executives choose words based on their total information. This includes much information that has already been disclosed or will be after the cc, but includes internal and non-quantifiable information that cannot be explicitly revealed, for example, expectations for the future.
Keep in mind that executives might wish to reveal or conceal information of the latter type. Druz et al. note: “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: Managerial tone surprises do predict future earnings
The study highlights that tone surprises do significantly predict future earnings. However, the effects are clearly asymmetric, that is, excessive negativity more strongly predicts lower future unexpected earnings than excessive positivity predicts higher future unexpected earnings. This relationship is maintained even when controlling for specific speech characteristics like words that express uncertainty or doubt.
Druz and colleagues also note sell-side analysts revise their forecasts downwards (or upwards) for the next quarter if the manager adopts an excessively negative (or positive) tone, but they tend to make greater adjustments to excessive positivity. The study measured uncertainty by the standard deviation of analysts’ post-call forecasts for next quarter earnings. Of note, negative tone boosts both that dispersion and the number of forecast revisions in the next quarter. Bid-ask spreads are another indicator of uncertainty as they jump from the day before a conference call with excessive negativity to around three days after.
The study also looks at whether managerial tone is more important when objective information is less informative. The authors note: “Large earnings surprises suggest that a firm is harder to read. tone surprises in presentations more strongly predict future earnings for firms with a large (positive or negative) earnings surprise. Similarly, in these “cloudy” firms excessive negativity in managers’ presentations and answers more strongly magnifies uncertainty (as indicated by higher variability of analysts’ forecasts).”
The researchers also say that the stock market reacts more to tone surprises in “cloudy” firms than non-cloudy firms. They say, taken as a whole, “these findings provide further evidence of a predominantly rational basis for stock market reactions to tone.” Moreover, the changes in share prices typically persist after the initial stock price reaction, as would be expected with a rational response. Also of interest, “experienced analysts do much better than novice analysts in reacting appropriately to tone surprises in both presentations and managers’ answers.”
See full study below.