What Investors Infer From External News And Management Silence

Uncertainty about outside news alters company disclosures and how markets interpret them, study finds

Communication between a company and financial markets is rarely a straightforward affair, especially when the topic is something managers have no obligation to discuss. When management remains silent, investors parse this silence for clues that management knows something it’s not saying. 

Reports of a competitor’s supply issues, an optimistic analyst note on the industry, rumblings about new regulations or positive economic trends — third-party news that may or may not reflect the true value of the company in question — all affect market pricing and, therefore, firms’ strategic dissemination of information.   

In a working paper, USC’s Jonathan Libgober, UCLA Anderson’s Beatrice Michaeli and Hebrew University’s Elyashiv Wiedman model how managers and investors react when the market is not certain that the third-party news is relevant to a firm’s share pricing. In their assessment, managers don’t always disclose good news, and they sometimes disclose the bad. And investors don’t always infer the worst when management remains silent.

Ultimately, the study suggests, the element of uncertainty about relevance can result in changes in share prices in unexpected ways. Investor assumptions about management’s disclosure preferences, paired with their guesses about whether the outside news is relevant, can lead to miscues in the silence. Even good news can cause prices to fall. 

Truth or Noise?

Every day, corporate leaders and shareholders are flooded with information about outside events that might affect their own holdings. In many cases, what looks at first like pertinent news proves irrelevant. The proposal for new regulation may fizzle out. The source of that takeover rumor turned out to be unreliable. That peer’s fantastic earnings report may be due to sales in a new (unrelated) market with no competition.

Consider, for example, reports of potential labor strikes at South Korean plants owned by a hypothetical gadget company, Chips. Managers at competitor Acme can decide whether or not to explain to its own shareholders what, if anything, Chips’ problem means for the value of Acme. Maybe there have been rumblings of worker discontent at Acme plants, too. Or maybe Acme management sees little threat of a similar fate due to its long-term labor agreements in the country, and Chip’s worries cannot affect the market share of Acme. 

The shareholders do not know if management is purposely withholding information about how that outside issue could spill over to their company or if they simply have no information to share. In addition, they are uncertain about the relevance of third-party news. Without guidance from management, investors assess the third-party information with “a grain of salt,” Libgober, Michaeli and Wiedman explain in their study. This element of skepticism appears to change the way both sides read each other and respond to third-party news, the study suggests. 

Silence Isn’t Always a Clue

The study implies that investors infer information about the relevance of outside news from management disclosure decisions, and vice-versa, even though the two are not cleanly linked. Management makes disclosure decisions based on maximizing share prices whether or not the news is good or bad, relevant or not.  

Investors, however, expect management to disclose good news. When the outside news appears to be good, according to the findings, they interpret the silence as meaning the outside news is less likely relevant to the company’s value, as otherwise the company would reveal such information. Shares that initially rose on the outside news may fall back as time goes on and management does not correct assumptions.

Despite conventional expectations about management withholding news that negatively affects the share price, the study suggests that managers speak up when they perceive market reactions to outside events as too harsh. Silence on unfavorable outside news could be due to a lack of relevance or information — aka, the Chips’ situation is unlikely to affect Acme, or Acme management doesn’t know if it could — rather than a known threat to the company’s future.

Libgober, Michaeli and Wiedman’s work suggests that investors tend to react more sharply on bad news than they would on good. They identify a possible reason for this diversion. Their research points to investor beliefs that silence in bad news is more likely relevant, and therefore worthy of a transaction, than in good news.