Are Corporate Managers Lying About Quarterly Results?

When corporate executives report quarterly earnings, those reports always look back at the most recently ended quarter and may or may not offer some indication of the company’s performance in the current quarter. The information that corporations share on current-quarter performance — usually in guidance or outlook statements — is difficult to verify for accuracy or even completeness.

A new research paper tries to determine whether this guidance information is used in the interest of shareholders or might it be used instead in the interests of corporate managers? In a paper titled “What Do Measures of Real-Time Corporate Sales Tell Us About Earnings Surprises and Post-Announcement Returns?,” researchers used a simple real-time corporate sales (RTCS) index as a proxy to estimate measures of sales activity both during (within-quarter) and after (post-quarter) the period.

Using big-data tools, the researchers were able to capture company-specific, real-time economic activity that tracks consumer activity. The important point here what happens at the time the company releases its quarterly results:

[B]ecause a firm’s managers likely have access to up-to-date information on the firm’s operations, our within- and post-quarter RTCS indexes are, at the time of announcement, useful proxies for managers’ private information, not available to the public.

As expected, the proxy for within-quarter measures is “strongly correlated” with the company’s announced quarterly results. The more interesting results come when the researchers measured post-quarter announcements (think guidance). They offer two alternatives: a “Timely Disclosure Hypothesis” in which managers release all their private, post-quarter information; or a “Leaning Against the Wind (LAW)” alternative under which “managers use discretionary channels to understate, even reverse, the private information contained in post-quarter RTCS.”

The researchers looked at three direct measures of discretionary disclosures: discretionary accruals; whether guidance (“bundled forecast”) rejects Timely Disclosure, and, if so, does it favor the alternative instead; and third, managerial tone in conference calls.

There was no strong correlation between discretionary accruals and post-quarter RTCS although there was evidence that among firms that marginally miss consensus forecasts, discretionary accruals appear suppressed when post-quarter RTCS is high.

The research showed a much stronger correlation when guidance is issued:

[B]undled forecasts are systematically negatively related to post-quarter RTCS. The probability of realized future earnings (or revenue) exceeding bundled forecasts is positively and significantly associated with post-quarter RTCS. As the LAW alternative would predict, managers issue more pessimistic (optimistic) forecasts – in this case, guidance — in the presence of more positive (negative) post-quarter sales information.

And as far as managerial tone on the conference calls, the researchers found “call sentiment is significantly and negatively related to post-quarter RTCS.” The better the post-quarter RTCS, the more pessimistic management sounds.

So, the researchers ask, “Why would managers consistently across channels, choose to understate or even reverse their private signal, leading the information withheld to leak out only slowly, post-announcement?” They answer their own question:

Clearly, if managers at announcement obscure fundamental information for a quarter, they enjoy a transitory informational asymmetry versus analysts and the market. This improves their post-announcement trade opportunities. We note that managers could in principal [sic] also induce equal-sized asymmetries by magnifying – i.e., overstating – their private signals instead of reversing them. … Thus our rejection of Timely Disclosure suggests reversal in discretionary announcements. Are insiders’ trades after earnings announcements consistent with this? While there are relatively few such insider trades in our sample, we find that the negative relation between post-quarter RTCS and announcement return is stronger when insiders subsequently purchase their firms’ shares.

In other words, it is conceivable that soft or weak guidance paired with insider information could give managers a chance to acquire stock in their company at a lower price. A more charitable view is that managers are just being cautious in order to avoid being accused of pumping up expectations that may later be unmet. Investors’ choice.

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