A Little White Lie – or Worse?


UConn Researcher Discovers that Retail Execs Downplay, Mislead Outlook in Reports to Stockholders

Many CEOs from major U.S. retailers tend to soften, possibly even distort, their company’s financial standings and offer stakeholders pessimistic predictions about the future, even when their companies are thriving.

That’s the conclusion of a new study, co-authored by UConn finance professor Namho Kang. He and his colleagues found that retail executives don’t always give stockholders a completely honest description of their company’s financial well-being during earning announcement reports. Some may even be providing misleading information for their own benefit.

“I was not surprised that the CEOs weren’t 100 percent honest,” Kang said. “But the negative emphasis really was surprising. Most investors think that CEOs tend to overstate achievements and future earnings prospect, but it turns out they often understate their expectations. I think that’s why our paper has received so much attention.”

Their research, titled, “What Do Measures of Real-time Corporate Sales Tell Us About Earnings Surprises and Post-Announcement Returns?” is pending publication in the Journal of Financial Economics. It has already received prominent publicity in Forbes, through CBS News, and beyond.

Namho Kang (UConn School of Business)
Namho Kang (UConn School of Business)

Kang, who joined the UConn faculty four years ago, co-authored the paper with retired Harvard Business School finance professor Kenneth Froot; Boston College professor and chair of the finance department Ronnie Sadka; and EDHEC Business School (France) professor Gideon Ozik.

The researchers investigated quarterly earnings announcements, which are usually presented a month or six weeks after the end of a fiscal quarter, and include a conference call by company executives to shareholders and stock analysts. By then executives have some insight into how the the company is faring in the existing quarter. Kang and the other researchers discovered that when a company seemed to have positive sales news, executives often presented a lackluster projection for the future, essentially downplaying the company’s good fortune. The trend seemed to be toward presenting a distorted outlook.

Kang and his colleagues investigated 50 large U.S. retailers, including Costco, CVS, The Home Depot, Target, Walmart and American Eagle Outfitters.

To analyze a company CEO’s remarks, the researchers first devised estimates of how the company was doing in ‘real time’ by collecting a host of user data, even, for instance, how many times directions to a company’s store were retrieved online. They found that this ‘real time’ sales estimates track revenue growth well and predict earnings surprises and errors in analyst forecast.

Next, using the real time sales estimate, they studied the way the retail execs disclosed information, including discretionary accruals, management forecasts and the “tone” they set during the quarterly conference calls, even tracking word selection. What they found was many executives understated the positive corporate sales information and withheld other key information as a “surprise” down the road.

The question is ‘Why?’ The researchers looked at managers’ private, discretionary trades during the window following the earning announcements. They found that understatement is often followed by insider purchase of the firms’ stocks.

“We conclude managers do not fully disclose their private information and instead bias their disclosures down when in possession of positive private information,” the researchers wrote. “The data suggests they may be motivated in part by subsequent personal stock-trading opportunities.”

The researchers have even suggested that the Securities and Exchange Commission, which protects investors, look into these practices and presentations.

“The average person, the typical investor should be very wary of what they hear,” Kang said. “You can’t 100 percent rely on what the CEOs say.”