We recently came across research originally published in October 20221 titled “Manager's Strategic Use of Concurrent Disclosures.” The study examined nearly 50,000 non-earnings related 8-Ks over a 14-year period where a firm also issued a press release. One of its key findings was that management teams were more likely to issue an unrelated press release when the news in the 8-K was negative. It also found that management teams were more likely to issue negative news on a Friday or after market hours. The research itself is interesting and expands upon prior work2 that disclosure processing is costly to investors and can lead to short-term mispricing of stocks.
These findings are certainly not shocking. Bundling news or downplaying negative news are tactics that have been employed for as long as we can remember. And while scientific research on the prevalence of such clever tactics or on the existence of information processing costs for investors can be interesting reads, we find that such analyses typically miss a key (and admittedly harder to quantify) risk for public management teams—erosion of trust.
Investing, in most instances, is a long-term game where one's reputation accrues over time. While it is entirely understandable and natural to want to downplay bad news, having consistent practices around how good and bad news is disseminated is critical to building and maintaining credibility with the investment community. Investors have an unparalleled ability to access information and they will process the information eventually, but if a company makes it difficult or goes to great lengths to “hide” it, such actions can likely chip away at management's credibility over time. Those “clever” practices backfire as investors lose confidence and patience with companies that play games.
Our key takeaway is that since the information will eventually be priced in, and the attempt to obfuscate it will ultimately not go unnoticed, why take the risk of damaging the relationship with a key stakeholder, the capital market.
It is difficult enough to operate a business successfully in today's environment. On the other side of the equation, investors evaluate myriad criteria in determining which companies to allocate capital to, some within a management team's control and some based on macro factors. One criterion that is firmly within management's control is credibility when confronting business realities. Not doing so simply creates a new reason for someone not to invest with you.
Tips for Success:
- Consistency – Create and maintain a clear framework and pattern on what information and how the company discloses as well as an appropriate level of materiality.
- Transparency/Clarity – Make your disclosures easy to digest and avoid burying important information deep inside a press release or in filing documents when possible. Utilize various channels, such as investor websites, regulatory filings, and investor presentations, to make information easily and consistently accessible. Provide supplementary resources that aid stakeholders in understanding and analyzing the disclosure.
- Timeliness – Make the disclosure when the audience can easily be expected to see it and react to it. Said differently, a disclosure at 5 pm on a Friday before a long summer weekend will be viewed as not being timely.
The key to strong relationships is trust. Management teams must recognize the risks associated with concealing negative news or employing “clever” tactics. While such strategies may temporarily hinder the pricing impact, they ultimately undermine trust and credibility with investors. Consistency, transparency, and timeliness in disclosing information are crucial for building and maintaining credibility within the investment community. In today's business landscape, where trust and perception play a pivotal role, prioritizing open and honest communication is crucial to attracting and retaining investment while navigating the challenges of the modern market.
Footnotes
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