Press releases that tout a company’s earnings in the headline should be looked at more skeptically, according to a new academic study.
The study, by Xuan Huang of California State University Long Beach, Alex Nekrasov of the University of Illinois at Chicago, and Siew Hong Teoh of the University of California, Irvine, questioned “managers’ opportunistic incentive to highlight temporary good performance by headlining.” It appears in in the November issue of "The Accounting Review," a journal published by the American Accounting Association.
Approximately 28 percent of the more than 17,000 earnings releases sampled in the study cited performance numbers in their headlines, tending to increase what the researchers referred to as the “salience” of a firm’s results. They found that increasing headline salience (such as when earnings exceeded forecasts, headlining by how much), lifted a company’s stock price beyond the rise typically prompted by good news. On average, adding one strong performance number to a headline increased a results-inspired boost by an extra one-third during the three-day period surrounding the earnings announcement.
Citing psychology research, the researchers see the extra boost as due to the effectiveness of headline numbers in attracting investor attention. In addition, “an initial favorable impression can lead investors to underweight contradictory information elsewhere in the report.”
But the researchers also warned investors to beware of the earnings touted in the press releases. After a quick rise in the price of the shares, there’s often a big reversal in the 60 days following the earnings announcement, a reversal greater than the initial boost that the salience gave the stock price.
"Investors not only undo their initial reaction due to salient headlines but even revise their beliefs in the opposite direction in the subsequent period," the researchers wrote. "Headlining quantitative information incites investor overreaction to the earnings news at the time of the earnings announcement ... This suggests that headline salience misleads investors."
Headline salience not only seems to portend a stock-price reversal over the next two months but longer-term disappointments too. Although they may flaunt strong current results in the headlines of their press releases, companies that do so, the researchers found, “have lower earnings persistence consistent with managers’ trying to make hay while the sun shines ... suggesting that headline salience choice is motivated more by opportunism than by a desire to make disclosure generally more informative.”
Of accounting terms appearing in headlines, the largest number were earnings-related, followed by those related to revenues. Companies’ earnings persistence was calculated by whether gains achieved from one year to the next were equaled or exceeded in a third year. The analyses controlled for an array of factors that can affect stock prices or company performance.
Both three-day stock returns and 60-day reversals increased with greater headline salience, with both going up as the number of headline statistics increased (for example, from zero to one or from one to two). While headline salience was effective when earnings were greater than analyst forecasts, that wasn’t the case when they weren’t. More salience didn’t attract investor interest when earnings barely met expectations or fell short of forecasts. Headlined earnings numbers had a greater impact when expressed as percentages instead of being stated in terms of dollars.
Salience decisions often coincide all too conveniently with the personal financial interests of top executives at companies. High salience, according to the study, was strongly associated with increased insider stock sales in the month after earnings announcements and also with the recent vesting of executives' stock.
“The evidence is consistent with managerial opportunism on the choice of headline salience,” said the study. “Firms in which managers intend to sell their firm's equity are more likely to choose headline salience to excite investor optimism about the firm. This enables them to take advantage of the high stock price when they sell after the earnings announcement."
Meanwhile, when there is personal financial benefit in a decline in stock price — that is, when an earnings announcement precedes a grant of stock options – managers “are less likely to use salience ... seeking to avoid increasing their option strike prices before grant awards.”
The study’s findings came from an analysis of corporate annual earnings press releases over an 11-year period. The researchers calculated salience as the number of performance statistics appearing in headlines. In approximately 72.1 percent of the earnings releases, there were none; in 11.9 percent, there was one; and in 8.5 percent there were two, in 2.9 percent three, and in the remaining 4.5 percent more than three.
