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The Ripple Effect
How a Company’s Forecast Can Impact Competitors
From time to time and for a variety of reasons, many publicly traded companies issue a management forecast of their earnings and/or revenues before the end of a financial quarter.
That sort of voluntary disclosure generally affects the firm’s stock price, but for some time economists have theorized that one company’s announcement could have an “information transfer” to its competitors — that, to a lesser degree, the announcement could affect rivals’ stock prices as well.
In the most thorough evaluation of that phenomenon to date, Yongtae Kim, associate professor of accounting at SCU’s Leavey School of Business, has joined with two colleagues to quantify the effect. Their paper, “Positive and Negative Information Transfers from Management Forecasts,” appeared in the September 2008 issue of the Journal of Accounting Research.
“Information transfers are an important topic,” Kim said. “People usually invest in a portfolio that’s diversified among certain types of companies, so we need to see the correlation of risks and returns between stocks.”
Kim and his colleagues did an exhaustive study of management forecasts by going through the Dow Jones News Retrieval Service from 1987 to 1993. Kim, who has long been interested in issues of voluntary management disclosure, proposed using the data to investigate the information transfer question. “It took a long time,” Kim said of the project. “From the point of getting the initial data to publication took more than three years.”
Previous studies had posited the existence of positive information transfers, in which one company’s announcement of good (bad) news led to a stock rise (decrease) in its competitors’ stock, but subsequent research showed that the evidence was weak when controls were imposed to correct for other market factors.
Kim conjectured two points that were both subsequently supported to some degree by the research. The first was that the information transfer from the same management forecast can be positive or negative based on the degree of competitiveness between the forecasting company and the firm receiving the information transfer. The second point was that positive and negative transfers may offset each other and lead to an overall finding of no information transfer even though both transfers exist.
“A negative information transfer occurs when a company announcement conveys a shift in market share relative to the competition, causing a market reaction in an opposite direction for rival firms,” he said. “If a firm forecasts good news, this may convey good prospects for its industry, thereby leading to a positive information transfer for firms in the same industry. But it could also mean market share taken away from rivals, which would lead to a negative information transfer.”
Generally speaking, Kim said, a positive transfer caused by industry commonalities is more likely to occur with companies that are not direct rivals of the announcing firm. A negative information transfer, based on competitive shifts, may prevail for companies that are direct rivals of the forecasting firm.
Using the Hoover’s handbooks of business, as well as 10-K forms filed by the disclosing companies with the Securities and Exchange Commission, Kim and his colleagues separate the companies that were rivals of the disclosing firm from those that were in the same area of business but not really competitors.
“The innovation in the paper was to separate negative and positive information transfers based on the characteristics of information receivers,” Kim said. “If you look at retailers as an example, Wal-Mart and Target are rivals, but Nieman Marcus isn’t really a competitor of theirs.” Making that distinction enabled Kim to calculate both positive and negative information transfers from the same set of management forecasts.
What they found about positive and negative information transfers can be valuable for investors and portfolio managers concerned with correlation of investment risks and returns, Kim said, but there’s also a public-policy implication to the research. “Policymakers may well be interested in the effects of voluntary management disclosures because that’s something that could affect how those disclosures are regulated.”