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How does the use of vague words affect market reactions?

Posted by
Swiss Finance Institute
Monday, November 7, 2016 - 09:00

In a recent article Prof. Alexander Wagner, SFI Chair from the University of Zurich, spoke about his research into the effects of positive and negative managerial tone on financial markets. In this second part of his interview with SFI, Prof. Wagner speaks about his research into the impact on the market of the types of words that managers use. Markets react to the words used in a communication, as well as the linguistic tone and vocal cues. The use (by managers, CEOs and CFOs) of either vague or clear language also affects market responses.


Dzieliński, Wagner, and Zeckhauser’s paper titled In no (un)certain terms: Managerial style in communicating earnings news deals with the issue in more detail.


Vague words

The research data consists of thousands of transcripts of earnings conference calls. It seems that there is a tendency of managers to use vague words like “maybe”, “approximately” and “probably” when times are bad. Certain managers use vague words more than others. This allows a classification of some managers as “consistently vague talkers” and some managers as “consistently straight talkers.”


There is also a notable difference in market reactions to managers who have a track record of straight, clear speech as opposed to vague speech.  Generally, the market believes future earnings announcements from straight talkers more and reacts more quickly to their announcements. Conversely, analysts and the stock market react more slowly and respond less to vague communications by managers. The evidence also suggests that “firms with vague CFOs have lower valuation ratios.”  


Overall, the results show that earnings (“hard information”) and straightforward managerial explanations surrounding this information (“soft information”) strengthen each other. That is, they are complements, not substitutes.


The impact of behavioral finance

Behavioral finance is the study of psychological and social factors of managers and investors that affect the markets, with the basic awareness that markets do not always follow rational paths as theorized in the Efficient Market Hypothesis.


Professor Wagner posits that the study of behavioral finance is important in assessing market activity because behavioral aspects seem to be central to decision-making (as opposed to the view that the use of behavioral assumptions needs to be justified after first trying to adhere to the standard economic model). People do not necessarily maximize utility in a self-interested way subject to certain constraints. Other preferences, such as the preference for honesty and helping others, also factor into decision-making.


In other words, human nature is a real factor in the markets. But this does not mean that the market is irrational or completely arbitrary. There are models, provided by behavioral finance research, that help to understand the markets while still accounting for human nature. Behavioral finance therefore gives structure and predictability to issues that may at first seem irrational or intangible.


Communication is key for business

Communication is an area where behavioral finance is particularly important. Creating an effective and carefully planned communication strategy is important for business because “while the disclosure of corporate financials is increasingly standardized, the human factor still plays an important role in interpreting earnings news.”


Faculty expertise provided by Prof. Alexander Wagner


To view the full interview, please click here.


Read the other posts in this series:

The Importance of Communication in Financial Markets.

How Does Managerial Tone Affect Market Reactions?