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Leadership & Organisations

Soft information or 'cheap talk' in company announcements: filling the 'void'

Next time you listen to a CEO talk about his or her company, play close attention to whether the person is being unusually optimistic or pessimistic. This sentiment can give you a good indication about where the company's stock price is headed.

Elizabeth Demers, Assistant Professor of Accounting and Control at INSEAD, has concluded a linguistic analysis of more than 20,000 corporate earnings announcements. Her research shows that both optimistic and very certain, unambiguous language can help a company's share price in the 60 days following the announcement.

Just as the market responds to positive or negative earnings surprises, unexpected optimism and certainty in the language, or unexpected pessimism and uncertainty in public announcements can have an added impact on the share price.

"We've known (this) for decades with regard to the hard earnings news, now we are discovering that this is incrementally true for the ‘soft’ earnings information as well," Demers says. "The market has a similar response to the sentiment conveyed in management's communications to the market."

While hard information is defined as quantitative data whose content is independent of the collection process, by contrast soft information is characterised as being only verifiable by the person who collected and produced it.

In their study, Demers and Clara Vega ( of the Board of Governors of the Federal Reserve System looked at two linguistic factors in the announcements: the number of optimistic words versus pessimistic words; and the number of certain and unambiguous words versus the number of less precise, hedging words.

These were measured over time, so the important factor was any new or unexpected change in the language used in announcements.

Demers discovered that both optimism and certainty in language played a role in share price movement after the announcements and that investors can earn several more risk-adjusted basis points by paying attention to the language and the soft news, which is regarded as being a similar concept to that of ‘cheap talk’.

"Unexpected positivism precedes positive, unexpected future price performance," she says.  So if a company announces a positive earnings surprise and the communication is positive as well, the stock price can rise further.  And even if a company announces unexpected negative news, unexpected positive language in the release can mitigate losses.

The degree of certainty in the use of assertive, forthright language is related to volatility in the firm's share price both at the time of the announcement and afterwards. The more unexpected certainty, the better for the share price; the more uncertain and hedging the language is, the worse it is for the share price.

The impact of both of these factors isn't just immediate in the days surrounding the announcement, but can continue to have an impact on the share price for 60 days.

"It takes the market some time to fully digest the soft information that's being conveyed by management during their announcement," she says.

The results came as a surprise to Demers and her co-author.

"What we actually expected to find is that the market would discount much more heavily the soft information or the cheap talk that management was putting out. And in particular we might have expected a firm with negative, hard earnings information to talk up the possible future prospects of the stock," she says.

But that's not what she discovered. "By and large, the evidence suggests that the market responds to it in same direction in which the executives are conveying it."

The authors underscore that they aren't suggesting CEOs engage in PR spin.  Their study dealt with real optimism or pessimism based on genuine facts in the company's business.

One other important factor for some companies with complicated businesses or high-tech firms with complex products is that the more they communicate and explain their businesses, the better. A simple earnings announcement doesn't convey the underlying economics of the firm.

"We find for those firms is that, by and large, the soft information has a greater impact on the share price and the reason for that, is that the soft information appears to be filling a void where the hard earnings information fails to fully convey the economics."

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