Retail executives aren’t always giving stockholders the straight scoop about the financial standing of their companies in comments around earnings announcements—and some may be providing misleading information, potentially for their own benefit.

That’s the upshot of new research by retired Harvard Business School finance professor Kenneth A. Froot in the April working paper What Do Measures of Real-Time Corporate Sales Tell Us about Earnings Surprises and Post-Announcement Returns?

“It’s startling to find that managers are not even neutral; they’re somewhat negative”

Froot co-authored the study with University of Connecticut Assistant Professor Namho Kang; EDHEC Business School Research Associate and Affiliated Professor Gideon Ozik; and Boston College Professor Ronnie Sadka, chairperson of the finance department, Carroll School of Management.

Quarterly earnings announcements, which typically are presented four to six weeks after the close of a quarter, often involve a conference call by company executives with shareholders and stock analysts. Part of those sessions may include executives giving soft “guidance” or other information about business prospects for the recently begun current quarter. But are they painting an accurate picture of a company’s current performance?

The researchers discovered something they didn’t expect: When a strong showing seemed to be under way for a company, managers at announcement often hinted at just the opposite—that the news was not so great.

“We thought if the company was continuing to do well, we’d see managers finding ways to convey that—wink, wink,” says Froot, who held the André R. Jakurski Chair before retiring from HBS in 2013. “That’s when we found this surprising result in direct opposition to what recent reported and unreported numbers said. It’s startling to find that managers are not even neutral; they’re somewhat negative.”

RESEARCHERS CREATE FORECASTING MODEL

To test their ideas, the researchers studied 50 big-box retailers in the United States, including Costco, CVS, The Home Depot, Kroger, Target, and Walmart. One of their biggest research challenges was how to determine whether a manager’s guidance was on target or misleading. They did so by constructing their own estimates of how a company was doing in real time by using data collected from a variety of consumer devices, including tens of millions of mobile phones, tablets, as well as desktop computers.

Do some retail executives mislead investors to win in the stock market? Source: Rawpixel Ltd

Consumer activity data included counts of specific events that appeared to involve a consumer’s intention to visit a particular retail store. For example, a search for driving directions to a Walmart was counted toward Walmart’s consumer activity for the week.

The researchers’ within-quarter measure accurately tracked current-period revenue growth and predicted announcement surprises and analyst forecast errors. Then they looked at post-quarter corporate information and studied three ways that managers disclose information: discretionary accruals, management forecasts, and conference call tone. In addition, they took a peek at managers’ private discretionary trades during the post-announcement trading window.

The researchers were trying to determine whether firms followed what they call the “timely disclosure hypothesis,” the idea that managers accurately release their private post-quarter information at announcement time.

What they found instead was that managers were “leaning against the wind,” communicating in a way that understated positive real-time post-quarter corporate sales information and withholding certain information as a “surprise for the future.”

Discretionary accruals—non-mandatory expenses or assets, such as a management bonus, that has yet to be realized but is recorded in the accounting books—didn’t point to managers “leaning against the wind.”

But in looking at basic stock return data, it became clear that managers understated their post-quarter private information. And in studying management guidance issued around earnings announcement dates, results suggested that managers gave more pessimistic forecasts when they had more positive post-quarter sales information.

WHAT’S THE MOTIVATION?

The same outcome was found when they studied managers’ voice tone during announcement conference calls using natural language testing that measures the number of positive and negative words used.

Although Froot, Kang, Ozik, and Sadka stop short of assigning a definitive explanation for this distortion of information, their research indicates that managers may provide misleading information for self-serving reasons: “The data suggest they may be motivated in part by subsequent personal stock-trading opportunities,” the paper says.

With some evidence that “a few are behaving badly,” Froot says the findings might prompt the US Securities and Exchange Commission to scrutinize weaknesses in the announcement process.

“We definitely think this merits further research and perhaps some examination by the appropriate authorities,” he says. “It’s likely that the SEC will want to have a look at this.”

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