Honesty is the worst policy for financial results

A US study finds that firms who bury bad news in their results statements end up better off...

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Last Updated: 31 Aug 2010

Honesty pays off in the end, we’re always told. But not according to the American Accounting Association: its latest journal includes a study of companies who have announced corporate restatements, i.e. admitted that their previously stated results weren’t actually right after all. And apparently, those who buried the news in a footnote at the bottom of their press release suffered less damage to their share price than those who ‘fessed up straight off. So maybe stealth is the better policy – although what this study doesn’t show is how this affects your brand in the longer term…

The three US academics behind the survey looked at 381 restatements between 1997 and 2002 (just before Sarbanes-Oxley kicked in). 157 made ‘high-prominence’ disclosures, i.e. in the headline of the release, while 189 put it in the body copy (medium-prominence) and 35 stuck it in a footnote (low-prominence). And after the authors corrected for other factors that could influence share prices (like other irregularities etc), they found that the high-prominence firms’ shares dropped by 8.3% relative to the rest of the stock market, compared to 4% and 1.5% for the medium- and low-prominence firms. And interestingly, the high-prominence approach also resulted in a class-action lawsuit in 27% of cases, compared to 16% and 0% for the other two.

The authors did note that share price movement evened out for the high- and medium-prominence disclosures over a 20-day period – whereas the former saw their share price plummet straight away, the latter saw a similar decline but over a longer period. However, as they pointed out, those 20 days can make all the difference: in-the-know managers and shareholders who bother to trawl through the press release can flog their shares at a higher price than if the company had been completely forthright. And they’d be better off still if the news had been dumped in a footnote, of course.

OK, so this is an American study of ten year old accounting statements, so perhaps we shouldn’t read too much into it. And we're not sure whether share prices do better because people can't be bothered to read all the way to the end, or because they think it's somehow more important/ urgent if it's right at the top. Nonetheless, it does send a rather unfortunate message about how companies should deal with bad news – which of course is not exactly in short supply at the moment.

Then again, we like to think that companies build long-term value by being honest with their shareholders. Hiding unwelcome news might spare their share price in the short term, but it won't do wonders for their reputation in the long term.


In today's bulletin:

BA bruiser Walsh picks fight with unions over job cuts
Amazon Kindle is coming to Britain
Sainsbury sounds cautious note as sales growth slows
Honesty is the worst policy for financial results
Route to the top: Six ways to swallow your pride

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