How Managerial Tone Affects Forecasts

A study found that analysts, investors and the market underreact to negative changes in managerial tone.

The sample period of data was from 2003 to 2016. Using conference call transcripts from Thomson Reuters Street Events, analyst forecast data from Institutional Brokers’ Estimate System (I/B/E/S), company fundamentals from Compustat and price data from the Center for Research in Security Prices (CRSP) the study’s authors discovered that the way company managers discuss earnings and performance dictates how analysts forecast earnings. Through the lens of a word list compiled by Loughran and McDonald in 2011, they discerned managerial tone through words that are considered negative, positive and uncertain.

Looking at value-relevant data, other speech patterns were addressed including “length of the conference call, inconsistency in tone, uncertain words, strong modal words (expressing level of confidence, such as ‘always,’ ‘definitely,’ ‘never,’ and ‘will’), words having to do with finance, the frequency of numbers, sentence complexity, and atypical tenses.” The study’s authors found that the use of uncertain words could make it more difficult for investors to value a stock. They deduced that the length of the conference call could mean that the company needs to explain more, possibly indicating a situation that requires more in-depth information.

When managers’ tone shifted bleakly, or negatively, this predicted “greater dispersion of forecasts regarding the next quarter,” but if their tone shifted brightly, or positively, there wasn’t much of a difference in analysts’ expectations. Companies with bleak tone changes in their conference calls “underperform the benchmark comprising other companies with similar characteristics.”

The study’s authors suggest that analysts and investors can learn from their findings that “they should have confidence that where currently they may be responding to company communications subtly, or even subconsciously, they are probably responding appropriately.” They also advise that some of the “tea leaf reading” being done should be tested on a statistical basis to automate the process and leave less room for error. If anything, analysts could “push further into investigations of language and psychology” if they want to be more certain about their forecasts based on managerial tone.

Source: “When Managers Change Their Tone, Analysts and Investors Change Their Tune,” by Marina Druz, Ivan Petzev, Alexander F. Wagner and Richard J. Zeckhauser; Financial Analysts Journal, March 2020.