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Companies Choreograph Earnings Calls to Hide Bad

Data from thousands of Wall

Street earnings conference calls

suggests that many companies

hide bad performance news by

calling only on positive analysts,

according to new research by

Lauren Cohen and Christopher


by Julia Hanna

The quarterly earnings conference

call is a traditional way for public

companies to disclose information

regarding performance and strategy

from the prior quarter. Wall Street

analysts and other company

watchers dial in, identify

themselves, and wait their turn to

ask the CEO or other top

executives a question.

That's the procedure that HBS

Associate Professor Lauren H.

Cohen followed to find out more

about the odd dealings he'd

observed at a company that was the

subject of one of his case studies.

But he wasn't given the opportunity

to ask a question, and the topic

wasn't raised by other callers. His

curiosity piqued, Cohen went back

to examine the public transcript of

the call.

"We looked at the people who [the

CEO] called on, and it was only

those who had strong 'buys' on the

company's stock," he recalls.

The exchanges between the analyst

and chief executive were

sometimes no more than a few

pleasantries and in one case, a

softball question that the company

knew was coming. "That made us

wonder if this was true more

generally across firms-that they

choreograph conference calls when

they don't want to talk about

"Nearly every firm finds it

useful to choreograph or

'cast' a call at some point

in its life"

This dance of deception was, in

fact, exactly what Cohen and

coauthors Dong Lou, of the

London School of Economics, and

HBS Professor Christopher J.

Malloy later found to be occurring.

The results of their research,

Playing Favorites: How Firms

Prevent the Revelation of Bad

News, were published in


To determine when and why

companies engage in this behavior

and what it might indicate about

their future earnings, the research

team examined roughly 70,000 call

transcripts from all publicly traded

US companies from 2003 to 2011.

For each call, Cohen and his

coauthors identified the name of

the firm and call participants, in

addition to matching analysts with

the recommendations they gave

before the call. Finally, they coded

the entire text of each question and

answer, classifying the length and

tone of each (positive or negative)

using a computer algorithm.


What they discovered was

surprising. This wasn't a small

number of companies manipulating

their earnings calls. "Instead, it

seems that nearly every firm finds

it useful to choreograph or 'cast' a

call at some point in its life by only

calling on analysts it could count

on for positive commentary,"

Cohen says.

The evidence made it clear that

firms can't cast calls forever. If

they do, analysts eventually drop

coverage-the tipping point seems to

be four calls in a row.

So what caused the firms to

periodically engage in such

behavior? What seems to be

correlated across the sample,

Cohen says, "is that a firm had

negative news that it wanted to


The researchers discovered a few

variables that made it more likely

that a firm would deliberately call

on favorable analysts. Not

surprisingly, companies that in the

past year had "pulled revenues

forward" (reported revenues before

they were earned) or otherwise

manipulated the books to make

their earnings look better, were

more likely to cast a call. "If you've

been engaging in somewhat shady

activity in your accounting books,

the last thing you'd want is to be

called out about it in a public

setting," says Cohen.

Also prone to call casting were

firms with earnings that just hit

analyst expectations or had beaten

them by a penny. "Research has

shown that firms will play around

with their accounting books to hit

or barely exceed analyst

expectations, since it's perceived to

be a very bad negative sign to fall

short," Cohen says.

Companies preparing for an equity

issuance and companies that

engaged in insider trading in the

following quarter also tended to

call only on positive analysts, for

the obvious reason that it would

boost the stock's sell price.


All this manipulation may be for

naught. The bad news eventually

comes out, resulting in negative

returns when it does.

"Firms that have cast their calls in

the past have substantially more

earnings restatements in the

future," says Cohen. "They come

clean when fewer people are

paying attention, or when the

timing is more advantageous."

This trend is so well established

that a simulated long-short stock

portfolio created by the researchers

to take advantage of this fact

earned abnormally high returns of

up to 101 basis points per month.

(In part, the portfolio shorted

stocks that had cast their earnings

calls a quarter earlier.)

Despite disclosure legislation such

as Sarbanes-Oxley designed to

ensure a transparent, level playing

field, Cohen says that casting calls

are a subtle but important way that

companies influence the

information they reveal to the


"What we find in the paper is that

markets don't seem to understand

this," he says. "This is all perfectly

knowable-the transcripts are

available 15 minutes after the call

is over--yet we still find that

returns aren't down until three

months later, when the bad news

comes out in the next call."

There are a couple of easy,

low-cost fixes, he adds-analysts

could be required to state their

buy/sell recommendation as they

joined the call, for example. Or

when the transcript was published,

it could include the names of

everyone who wanted to ask a

question and didn't get into the call.

"The question is, how big of an

impact is this having, and do

people understand that it's

occurring?" asks Cohen. "The

answer seems to be no. So what

should we do about it, if anything?

We're still very much at the point

of starting that conversation, but

we think it's an important one to

About the author

Julia Hanna is associate editor of

the Harvard Business School
Alumni Bulletin.



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