Great quarter, guys!’ This conference call cliché sums up why many disdain dialing in to corporate earnings sessions. They seem to exist only for sell-side analysts to vie for executives’ favor.
Even so, investors are entitled to wonder why the buy side insists on neglecting this opportunity to interrogate chief executives and chief financial officers. A new review of a sample of more than 2,200 earnings calls found that only 7.14% of non-management participants were from investment houses. The majority of these were from hedge funds, with just 1.7% coming from mutual funds.
Why are fund managers so reticent to join these calls? The paper’s authors – the University of Queensland’s Vanitha Ragunathan, alongside Ling Cen, Yan Xiong and Liyan Yang, all from the University of Toronto – propose one answer.
‘Our starting point is the assumption that buy-side participants have more precise private information about the firm’s value than sell-side analysts,’ they explained.
‘Relative to sell-side analysts, buy-side institutions bear a larger cost in participating in earnings conference calls, since other institutional investors may acquire information from their questions and front run their investment ideas. When buy-side institutions participate in earnings calls, it signals that the benefit from confirming important private information overwhelms the cost of information leakage and front running. Therefore, we expect more precise information from buy-side participants.’
Anecdotal support for this theory lies in what has been called the ‘Einhorn Effect.’ On a Herbalife earnings call in May 2012, David Einhorn – the founder of Greenlight Capital, who famously shorted Lehman Brothers before it collapsed – asked the company’s executives a few pointed questions about their sales practices.
Within minutes of those queries, Herbalife’s share price had dropped by almost 10%. By the end of the day, it had plunged by 20% and the daily trading volume in the stock was 15 times higher than it had been the previous day. Herbalife had gained 36% in the calendar year before Einhorn’s intervention; from that day, it lost 58% of its value.
That is obviously an extreme example, but the researchers discovered that it was not anomalous. Fund managers rarely contribute to earnings calls, but when they do it does seem to have an impact.
The study divided trading days into 130 slots of three minutes each and synchronized these with the timing of individuals’ questions during the conference calls. In those time slots when participants from the buy side spoke, there was an increase of 5.3 percentage points in the probability of substantial price action relative to that for sell-side analysts. This effect was both economically and statistically significant, with the impact proving to be particularly strong when the questioner was from a hedge fund.
As may be expected given the Einhorn experience, time slots associated with hedge fund speakers were more likely to prompt negative price movement than positive jumps in share prices. Time slots featuring managers or analysts from mutual funds, on the other hand, were more likely to be linked with positive rather than negative reactions in the share price.
‘This result implies that buy-side institutions might specialize in producing different types of information, a function of their trading strategies and economic incentives,’ the academics suggested. ‘Specifically, hedge funds that use a long/short strategy are more sensitive to negative information than other buy-side firms, and mutual funds – which typically follow a buy-and-hold strategy – are more sensitive to positive information than other buy-side institutions.’
Yet while the market may derive information from the questions posed by the buy side, the fund managers themselves get short shrift from the corporate executives. They not only tended to be called upon much later in the conference call than sell-side participants, but the replies to their questions were also on average 28 words briefer than responses to the sell side.
However, those curt answers did not appear to dampen the impact of a fund manager simply showing up. The market evidently knows that mutual funds are reliable cheerleaders, but hedge funds are predictable bullies.