"A premium for candor": how top executives' comments affect companies' share prices

How do you "hear" a company's future stock returns? Researchers from the University of Limerick and S&P Global Market Intelligence answer: check how top management responds to analysts' questions during conference calls. It turned out that more specific answers yielded almost up to 4% extra returns per year. How does this work and how will it help investors better evaluate their investments?

The study, which was published in the Journal of Investment Compliance in May of this year, analyzes 164,944 conference calls from the quarterly reports of companies in the Russell 3000 index from 2008-2024. This is a broad U.S. stock index that includes 3,000 of the largest publicly traded companies and covers approximately 98% of the U.S. stock market capitalization.

The researchers analyzed how clearly and specifically top management of companies responded to analysts' questions. To do this, they conducted a semantic analysis of analysts' questions and management's responses, and then compared how meaningful and direct managers responded to the questions posed and whether they were evasive.

In the end, they calculated a coefficient: a higher value suggested that management was more accurate in "hitting" the topic of the question, while a lower value suggested that it was more like avoiding the answer.

The authors built into standard factor models (describing the relationship between an outcome and the factors influencing it) a semantic matching metric, as well as text parameters: overall positivity/negativity, understandability of numerical disclosures, complexity of language, etc. So they show, in effect, the "honesty of the answers".

How it works as an example: the researchers took a conference call of LanzaTech, a biotech company that converts carbon emissions into clean fuels and chemicals. At it, an analyst asks a specific technical question about the differences in the production of different types of products and the capabilities of the microorganisms used for processing, and management responds with a passage about the "circular economy," market size, and "turning pollution into profit." The semantic similarity of such a question and answer pair was 0.248, a low coefficient. The authors point out that the question was about one thing and the answer was about another.

The researchers showed: all else being equal, companies whose management provides more specific answers on average yield about 0.8% additional return per month compared to those whose management answers are more evasive. They also claim that following a strategy of being "long on companies with specific and honest answers and short on evasive ones" would yield about 3.86% additional returns (annualized alpha) for companies in the Russell 3000.

The difference in profitability is almost evenly distributed. As top management answers "become" less specific, the profitability of companies systematically deteriorates: projects with maximum semantic overlap between questions and answers earn about 1.85% per month, while at the other pole it is about minus 1.95% per month.

In small caps - in the Russell 2000 index - the difference between those who answer to the point and those who evade questions comes to about 4.5% additional return per year.

It turns out that the smaller the company and the higher the "information asymmetry", the more weight is given to high-quality and direct communication of top management. Large issuers are followed by more analysts and media, so investors can get a lot of information from other sources. As a result, the importance of management's answers, or rather their "weight", is lower.

The researchers also concluded that the directness and specificity of management's answers are related to future company fundamentals. Projects with high semantic coincidence of questions and answers show higher gross profit to assets ratio, more moderate debt load and better profitability in relation to the company's valuation after one year. The authors of the study conclude: this is how the market evaluates not only the communication style itself, but also the management competence behind it.

Why it happens. Investors and analysts are always working under a high cognitive load and dealing with time constraints, so direct, specific answers speed up information processing.

Evasive answers, on the other hand, require resources to "translate" words into meaning. The individual cognitive distortions of a particular investor or analyst become embedded in this translation, increasing the likelihood of error and slowing the response to the information received.

First, the study provides a new metric, "answer honesty." Semantic similarity between questions and answers is a factor that can be evaluated, ranked, built into models and tested.

Second, when listening to the next Q&A session or reading the transcript of a conference call, you should focus more on whether the top manager is answering the question at all. Perhaps he or she is just hiding problems behind beautiful narratives. And this may be a reason to look more closely at the state of affairs in the company.

This article was AI-translated and verified by a human editor