Playing Favorites: How Firms Prevent the Revelation of Bad News

Abstract

We explore a subtle but important mechanism through which firms can control information flow to the markets. We find that firms that “cast” their conference calls by disproportionately calling on bullish analysts tend to underperform in the future. Firms that call on more favorable analysts experience more negative future earnings surprises and more future earnings restatements. A long-short portfolio that exploits this differential firm behavior earns abnormal returns of up to 149 basis points per month, or almost 18 percent per year. We find similar evidence in an international sample of earnings call transcripts from the UK, Canada, France, and Japan. Firms with higher discretionary accruals, firms that barely meet/exceed earnings expectations, and firms (and their executives) that are about to issue equity, sell shares, and exercise options, are all significantly more likely to cast their earnings calls.