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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
"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.
BAD NEWS BEARS
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,"
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.
COPYRIGHT 2013 PRESIDENT AND FELLOWS OF HARVARD COLLEGE 1
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.
BEWARE FUTURE EARNINGS
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
HARVARD BUSINESS SCHOOL | WORKING KNOWLEDGE | HBSWK.HBS.EDU
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