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How Does Managerial Tone Affect Market Reactions?

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Swiss Finance Institute
Thursday, November 3, 2016 - 10:00

In our interview with Prof. Alexander Wagner, SFI Junior Chair from the University of Zurich, Prof. Wagner explains how managerial communication affects market reactions, with a special focus on the impact of positive and negative language.


Druz, Wagner, and Zeckhauser’s paper titled Reading Managerial Tone: How Analysts and the Market Respond to Conference Calls deals with the issue in more detail. It builds on existing work that markets react not only to the words used in a communication, but also to the linguistic tone and vocal cues. Thus, the “more subtle aspects of corporate communications also matter.” The key question this paper answers is why the market responds to tone.


Research into managerial tone

Numbers are generally seen as the key driver of markets. However, there has been increasing research around how these numbers and how the fortunes of companies are communicated by managers. By looking at earnings calls that managers hold with analysts, researchers use algorithms to extract the positive and negative tone of managers’ statements.


Generally, as one would expect, negative tone gives rise to a negative market reaction, whereas positive tone gives rise to a positive market reaction. The present research provides evidence that this is due to a rational reaction: “market participants rationally distil value-relevant information from managerial tone that is unexplained by past results and public information about a company’s future.”


How is tone determined?

First, researchers qualify and count certain words that managers use in conference calls. For example “decline” and “difficult” count as negative words, whereas “strong” and “opportunities” count as positive.  


Second, the positivity or negativity is calibrated against what could be expected at that point in time for that company and that manager. For example, it was expected during the financial crisis of 2008 that most corporate managers would adopt a negative tone because of the difficult market conditions. Even a fairly moderate positive tone would have been quite surprising. By contrast, in a positive market environment, when earnings beat the forecast, even a moderately negative tone will be surprising.


Additional patterns of speech are of separate interest but they can serve as warning flags or explanatory variables. An example of this is when inconsistency in tone is present (for instance where the tone of prepared remarks varies considerably from the tone of improvised speech).


Tone predicts earnings, uncertainty, analyst responses and stock reactions

Is the reaction to tone a matter of sentiment or a matter of rational responses? The research shows that there are rational reasons for the stock price reaction to tone. Tone surprises help predict both future earnings and uncertainty, the two drivers of company value. Moreover analysts also react to tone, though there tends to be a lag in their reactions. Importantly, stock prices do not revert after the initial reaction to tone, but continue to drift, suggesting that tone has actual information content, but is not priced fully immediately.


The impact of tone disappointment is greater than tone delight

The research shows that a surprisingly negative tone (tone disappointment), is a strong indicator of bad things to come, whereas a positive tone (tone delight) has only moderate positive effects on the market. The plausible reason behind this is that people expect positive news and that there are some things management prefers not to say about negative news. Many people have been taught "if you can't say something nice, don't say anything at all".  Therefore, if a manager does say something surprisingly negative, this means he overcame the natural inhibition against saying negative things. As such, such statements can be expected to have strong information content.


Can managers attempt to portray a certain tone?

While managers probably receive media training, there are times when they cannot be well-rehearsed, for example in a question and answer session. The research includes a mix of responses from managers, some of which may have been anticipated and therefore prepared to some degree, while some of the responses are unanticipated. These impromptu responses might provide a more honest, unrehearsed reaction. 


Communication strategies are important in business

In summary, the positivity or negativity of a manager’s tone, in particular the tone surprise, are important indicators for the market. Market participants “read between the lines” to understand information conveyed by managers through tone, “purposefully or inadvertently.”


The research highlights the importance of communication strategies for business, since subtle forms of communication (and not only numbers) also impact market reaction.


Faculty expertise provided by Prof. Alexander Wagner


To view the full interview, please click here.


Read the first post in this series : The Importance of Communication in Financial Markets.