Newspaper article St Louis Post-Dispatch (MO)

Look out Below: When CEOs Are Optimistic, Their Shares Underperform

Newspaper article St Louis Post-Dispatch (MO)

Look out Below: When CEOs Are Optimistic, Their Shares Underperform

Article excerpt

Everyone likes a confident CEO, but an overconfident one can be dangerous.

Consider Kraft Heinz' conference call last May, which Chief Executive Bernardo Hees began by saying he was "feeling more confident about our outlook." Nine months later, Kraft would slash its dividend and write down its brands' value by $15 billion.

Or go back to January 2018, when CEO John Flannery declared that General Electric was "beginning to show progress against each of our key initiatives." After slashing GE's dividend in July, Flannery would be out of a job by October.

If only someone would warn investors to take such pronouncements with a grain of salt.

Actually, two Washington University professors have co-authored a paper that looks at manager sentiment, as measured by the words executives use in conference calls and annual reports, and tracks it against stock prices.

The paper, which will be published in the Journal of Financial Economics, finds that manager sentiment is "a strong negative predictor" of future returns. CEOs who use a lot of upbeat words wind up disappointing investors.

They aren't necessarily trying to mislead anyone. Xiumin Martin, an accounting professor at Washington University's Olin Business School, says the bosses appear to believe what their rose-colored glasses are telling them.

"Managers believe what they say and act on it in terms of guiding their investment decisions," says Martin, who conducted the study with Olin colleague Guofu Zhou and co-authors from the University of Georgia and Central University in China.

The most optimistic CEOs overspend on capital projects, research and acquisitions. It's when those investments don't pan out that the stock price starts sinking.

The professors studied company disclosures from 2003 to 2014. Their sentiment index was a strong predictor both for individual firms and for the market as a whole, which may indicate some herd behavior on the part of executives. …

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