Author: Paul Brockman, Xu Li, and S. McKay Price (Lehigh University)
Publisher: Social Science Research Network Working Paper
Date Published: March 2012
Many top managers don’t practice what they preach when they trade their companies’ shares, according to this paper, which finds that the tone communicated by executives during conference calls with investors frequently runs contrary to the way they subsequently buy or sell their stock. When senior managers speak in pessimistic tones during these calls, they are significantly more likely to purchase company shares in the next 90 days, the authors found. The opposite is also true: After using an upbeat tone, managers are more likely to dump their stock.
If managers have an optimistic view of recent operations and future prospects, it stands to reason that their presentation and post-call trading actions should both reflect their positive outlook. Similarly, if managers think business has been going poorly and isn’t likely to improve soon, they would be expected to strike a dour tone and move to sell their stock. But this paper concludes that some managers are deliberately manipulating the tone of their conference calls and misleading investors in order to give themselves an advantage.
“Although it is always difficult to ascertain actual intentions,” the authors write, “the evidence clearly suggests a strategic purpose behind ‘saying one thing, and doing another.’”
The researchers collected a sample of 2,880 conference call transcripts during the 16-quarter period from 2004 through 2007. They applied computerized textual analysis to each call, determining the level of optimism or pessimism expressed by senior managers via word choice and how frequently certain terms were used. The transcripts contained both prepared introductory statements and question-and-answer remarks.
Because prior studies have concluded that trades made by top management are much more informed than trades made by non-executive employees, the researchers analyzed transactions made by CEOs, CFOs, COOs, chairmen of the board, and presidents. The trading data came from the Thomson Financial Insider Trading Monitor database, and was matched with stock data from the Compustat and Center for Research in Security Prices (CRSP) databases. The authors constructed a random sample of firms from these databases, with a wide range in company size and book-to-market equity.
The authors found, as expected, that senior managers do more selling than buying of their company shares. On average, high-ranking executives made almost four sales transactions per quarter, more than twice the number of their purchases.
But after controlling for variables that could affect the executives’ trading activity, the authors found that managers tended to trade in the opposite direction of what was implied by the tone they used during their conference calls. After extolling firm performance, managers were more likely to sell their own shares over the next three months, and after talking down the company’s prospects, they were more likely to buy stock. For example, the authors found that even a minimal increase in positive tone was followed by nearly two more sales of company stock than purchases, on average, during the next 90 days.
The results held up whether the researchers measured trading intensity via the number of shares or the number of transactions, and also across 30-day, 60-day, and 90-day windows. Most of the managers’ tone was conveyed during the Q&A portions of the conference calls. In other words, prepared statements at the start of the meetings were generally more neutral, but when making off-the-cuff remarks or responding to questions, the executives tossed in more of their own opinions about the current state and future of the company.
Because CEOs are likely to take responsibility for setting the tone of a conference call, the authors also tested whether CEOs spoke and acted differently than other managers. They found that CEOs had the widest disconnect between the tone they expressed and the trading they did later.
Analyzing the firms in the sample according to size, the authors showed that there was a much stronger inverse relationship between call tone and trading activity at smaller firms, where executives can more easily influence stock price valuations because their companies are not followed as closely by outsiders. “Such firms have fewer analysts following their performance, less institutional ownership and monitoring, and little if any media coverage during the earnings season,” the authors add.
The “striking” results, they note, aren’t driven by a simple contrarian trading strategy. For example, if the company’s stock has slumped in the months before the conference call, leading the CEO to think the firm is undervalued, it’s not surprising that the CEO would be a net buyer subsequently. But it would be very surprising for that same CEO, believing the firm’s stock to be a bargain buy, to use a downbeat tone during the conference call.
Managers do not put their money where their mouths are, according to this paper. When top executives strike a positive tone in conference calls, they are more likely to sell their own shares in the subsequent months. And when they express a downbeat outlook, they tend to buy more stock.