Companies that “choreograph” earnings calls by only taking questions from bullish analysts are usually hiding negative information and tend to underperform during future quarters, according to a new working paper by professors at Harvard University and the London School of Economics and Political Science.
The working paper, “Playing Favorites: How Firms Prevent the Revelation of Bad News,” found that firms with higher stock-price volatility “cast” their calls by taking questions from analysts who view them favorably. That practice often leads to drops in future earnings, the authors found in the study. Additionally, firms that manipulate calls often have higher accruals and are barely meeting earnings forecasts. In the following quarter, insider selling at these companies skyrockets, the paper says.
The authors reviewed transcripts from every conference call of publicly traded U.S. companies from 2003 to 2011. In the transcripts from Thomson Reuters, they were able to see which analysts companies selected during the call and how favorable and accurate the analysts’ past recommendations were.
For example, the report looked at packaging material company Sealed Air Corporation’s first-quarter earnings call in April 2007. Eleven analysts covered the company’s call but the firm only called on those that gave high recommendations on Sealed Air leading up to the call. According to the report, the analysts complimented the firm and joked with the CEO but did not push him on the upcoming quarter. At the second-quarter earnings call three months later, Sealed Air missed expectations and had its first negative cash-flow quarter.
There’s nothing illegal about firms calling on bullish analysts over bearish ones, says Harvard Business School professor Lauren Cohen, who authored the report along with HBS professor Christopher Malloy and LSE professor Dong Lou. But “casting” calls is ultimately misleading to analysts and investors, he says. Managers who invite questions from sell-side analysts but keep buy-side analysts sidelined on the call often miss out on questions that would dig deeper into the data. Their behavior may also ultimately lead analysts to stop covering the company, Cohen says.
Cohen suggests the Securities and Exchange Commission add regulations to make earnings calls more transparent. When a call begins, analysts should list their recommendations so listeners will know if the person has a strong buy or sell on the stock. Listing the callers — even those who don’t ask questions — also would help the company be more transparent. “It wouldn’t cost a firm or the SEC that much,” he says. “It’s a pretty simple and low-cost solution.”
Additionally, CFOs “can be more egalitarian in their calling patterns,” Cohen says.