Gains from spinning the news2 min read . Updated: 29 Jan 2010, 10:27 PM IST
Gains from spinning the news
Gains from spinning the news
Solomon finds evidence that IR firms generate greater media coverage of their clients’ good news compared with their bad news. That is hardly surprising—after all, which company would pay IR firms to give more coverage to bad news. His second finding, which is much more interesting, is that public relations firms are able to spin non-earnings announcements more than earnings releases. That’s very plausible, because earnings announcements contain precise numbers that can be seen through by analysts, making them difficult to spin, though not for want of trying. The problem is the positive spin on news items leads to higher expectations by investors which, in turn, raises stock prices. Unfortunately, though, if the earnings do not measure up to these heightened expectations, investors are disappointed and the stock falls. Putting a positive spin on news is therefore a double-edged sword for companies. Says Solomon, “Earnings returns are significantly more negative if there were higher returns since the previous earnings announcement, and after greater media coverage of positive press releases."
Of course, not all IR firms can do the job—they need good contacts with journalists. More importantly, Solomon finds that “reporters and newspapers are not unbiased in their decisions of which stories to cover. Instead, they are susceptible to influence by IR firms, which are able to increase the chances of receiving coverage of particular stories. Moreover, this influence appears to operate through the channel of personal connections between reporters and IR firms." He also points out that IR firms can spin the news more in newspapers that operate in the same region as the IR firm and company as well as in newspapers that are historically susceptible to IR firm influence.
Which companies would like to use IR firms to affect their stock prices? The paper says that it depends on the incentives company managers get to manipulate stock prices. For instance, “A higher proportion of CEO pay in stock and option compensation predicts a higher probability of using an IR firm." What’s more, Solomon also mentions that companies prefer to release positive news releases from Monday to Thursday, when investor attention is higher.
Finally, is there any way savvy investors could use this research to their advantage? Solomon says there is and suggests a trading strategy around earnings announcements: Buy companies that do not use IR firms and short companies that use IR firms. The logic is simple—since earnings expectations have already been bid up by the IR firms, stock prices of the companies that use them are likely to fall after earnings are declared, while the ones that don’t use IR firms will not see any such impact.
But perhaps the most important insight is that while positive spin may benefit a company’s stock, it will do so only till the next earnings announcement. As Solomon puts it, “The results in this paper suggest investors do not distinguish between media coverage arising from IR influence and media coverage from general newsworthiness, and are surprised when hard information turns out to be worse than expected. Investors, it appears, can be fooled, but not forever."