How Firms Prevent the Revelation of Bad News

...firms that engage in conference call casting experience higher short-term returns, but later suffer negative returns when adverse news is released...

A number of laws and regulations govern the timing and type of information disclosed by public companies, as part of an overall effort to create a level playing field for institutional and individual investors. In Playing Favorites: How Firms Prevent the Revelation of Bad News (NBER Working Paper No. 19429), authors Lauren Cohen, Dong Lou, and Christopher Malloy examine one way companies can discourage the disclosure of negative information in spite of these regulations: by managing or "casting" their earnings conference calls.

The study examines how firms can cast their earnings conference calls by disproportionately calling on bullish analysts and thereby avoiding the release of negative information that they would like to avoid publicizing. The authors compile conference call transcripts, analyst coverage reports and recommendations, quarterly financial data and earnings restatements from firms, stock prices, and other information for the years 2003 through 2011. Reviews of individual company data and conference call transcripts sometimes reveal clear examples of casting; in one case, a firm called exclusively on analysts with bullish recommendations on the firm's stock. Though not every instance of casting is so overt, the authors show that many firms appear to cast conference calls and often only release negative news months after these calls.

The authors find that firms that engage in conference call casting experience higher short-term returns, but later suffer negative returns when adverse news is released, compared to their counterparts that do not correspondingly manage their calls. The authors estimate that a long-short portfolio that would go long on non-casting calls and short on companies that cast their calls would earn abnormal returns of between 91 and 101 basis points per month. They find no evidence of return reversal in the future, suggesting that the negative information that was not revealed on the calls that were cast was important for fundamental firm value.

Firms in the data sample were more likely to cast their calls when they barely met or exceeded earnings expectations or when they were about to issue equity, which could have generated incentives to keep share prices high to maximize proceeds from the stock sale. Casting also appears to be more likely at firms that are covered by fewer analysts, have fewer institutional owners, and are more volatile.

--Jay Fitzgerald