Earlier this week, we discussed a March 2016 study by Rodney Boehme, Veljko Fotak and Anthony May, “Crash Risk and Seasoned Equity Offerings,” which provided evidence that companies will tend to withhold (and accumulate) bad news for an extended period of time, keeping stock prices temporarily higher (think WorldCom and Enron). Bad news, however, cannot be postponed indefinitely.
When the accumulated bad news is eventually revealed, the stock performs poorly (with a significant increase in the risk of the stock price crashing). They concluded: “Our research shines the spotlight on an observable corporate event that embodies useful information regarding future tail risk in equity returns.”
Evidence From Earnings Announcements
Joshua Livnat and Li Zhang, authors of the study “Is There News in the Timing of Earnings Announcements?” which appears in the winter 2015 issue of The Journal of Investing, provide support to the theory that firms tend to delay the announcement of bad news. They also show that firms tend to accelerate the delivery of good news.
The logic behind delaying a bad surprise could be to allow for the raising of new capital at costs that don’t reflect the negative surprise. This is the hypothesis, and the findings, of the aforementioned paper from Boehme, Fotak and May.
In delaying bad news, managers also might hope to provide time for the delivery of good news that might “soften the blow” (such as new orders or the introduction of new products). On the other hand, firms might rush to deliver good news to avoid the risk that some negative event may occur that would distract from the positive news. If these hypotheses are correct, investors might be able to capitalize on the information and generate abnormal returns.
With these hypotheses in mind, Livnat and Zhang examined stock returns following events in which firms’ earnings announcement dates were changed from previously announced dates. Given the availability of data, the authors’ study covered the period 2006 through 2013. Following is a summary of their findings:
- Firms that delay their earnings announcement dates after they have communicated an earlier release date actually have negative returns of 177 basis points from two days after the status change date through one day after the actual earnings announcement.
- For firms that delay their earnings announcement date, the actual earnings surprise is significantly negative, indicating the delay is likely due to negative information.
- On the other hand, firms that advance their earnings release date are more likely to have positive surprises and positive returns.
- A trading strategy that goes long firms that advance earnings announcements and short those that delay announcements generates significantly positive abnormal returns.
For several decades now, the academic literature has hypothesized that there are incentives for managers to both delay the announcement of bad news and accelerate the delivery of good news. Recent findings support this hypothesis. Thus, it appears investors can benefit from this knowledge. An interesting question is whether, now that the information has been published and become well known, the “anomaly” will persist.
If you are an investor in individual stocks, at least you’re aware of the tendencies. Perhaps mutual funds, even passively managed funds, will incorporate this information. For example, if a stock delays the announcement of earnings, the mutual fund might suspend any purchases until after the release of earnings. Or, if a mutual fund was in the process of selling shares, it might put a higher priority on selling the stock of a company that has postponed its earnings announcement at a faster pace by being more aggressive in accepting bids.
On the other hand, if a firm moved up its earnings announcement date, a mutual fund that was going to sell shares might delay the sale until after the announcement date (or accelerate purchases that might otherwise have been made, perhaps by being more aggressive in their bids or more willing to accept offers). In this way, even passive funds using patient trading strategies and buy-and-hold ranges can use the information contained in the date changes of earnings announcements.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.