Can executives predict how firm news maps to stock price?
Research shows surprising insight into how investors’ beliefs change after publication of quarterly financial reports.
The challenge:
Corporate executives have strong incentives to accurately predict the stock price reactions to news they disclose. This ability is crucial for timing transactions, controlling their firms’ narratives with investors, and understanding the price impact of strategic and operational decisions revealed in their disclosures. However, the extent to which they can do so accurately, especially during periods of market volatility and uncertainty such as the onset of COVID-19, is unknown.
Research shows surprising insight into how investors’ beliefs change after publication of quarterly financial reports.
The challenge:
Corporate executives have strong incentives to accurately predict the stock price reactions to news they disclose. This ability is crucial for timing transactions, controlling their firms’ narratives with investors, and understanding the price impact of strategic and operational decisions revealed in their disclosures. However, the extent to which they can do so accurately, especially during periods of market volatility and uncertainty such as the onset of COVID-19, is unknown.
The intervention:
The researchers conducted a field study to provide direct evidence of executives’ accuracy. They recruited over 650 U.S. public company executives to share their predictions of the stock price response to their companies’ second 2020 quarterly reports. The study examined the distribution of these predictions, their short-term accuracy, and how long it took for stock prices to converge to managers’ initial expectations over subsequent weeks and months.
Despite market volatility and uncertainty during the pandemic, executives correctly predicted the direction of stock return in two-thirds of cases. The study also found that executives’ short-window expectation errors predict returns. Following their companies’ reports, executives traded against the market in line with their initial error, and stock prices largely converged to their expectations over the subsequent 100 trading days.
The impact:
The results suggest that the more inaccurate their estimates are, the less executives engage in corporate window-dressing, and they do not appear to learn from unexpected price movements. They also suggest that executives have surprisingly good foresight regarding how investors’ beliefs will change after the reports, albeit with a delay. Collectively, the results provide evidence of executives’ superior ability to anticipate how the market prices information in quarterly financial reports, even in periods of extraordinary change.
