When a public company’s financial results take a hit, leaders can stop a freefall in the company’s stock price if they publicly accept the blame for poor performance, new research reveals.

Researchers from the University of Missouri found companies that performed poorly yet blamed other parties—such as the government, competitors, labor unions or the economy—experienced significant blows to their stock and had difficulty recovering.

Companies that accepted blame and had a plan to address their problems stopped the decline in their share prices after their announcement, but those companies that blamed others continued to experience falling share prices for the entire year following their public explanation.

“Honesty is appreciated, especially when it’s a difficult message from leaders,” said Stephen Ferris, professor and senior associate dean at the MU Trulaske College of Business, in a statement explaining the research. “Investors will accept a forthright recognition of an honest mistake, expecting that corrective actions are likely to follow. When firms explain a negative event as due to an external cause, company leaders can appear powerless or dishonest to shareholders.”

In the study, Ferris and his co-authors, Don Chance of Louisiana State University, and James Cicon of the University of Central Missouri, reviewed company announcements from 1993 through 2009 and identified 150 announcements describing poor company performance. The researchers found that most–slightly more than two-thirds of the announcements—attributed the poor performance to external forces.

Actually, filter those announcements where poor performance was, in fact, legitimately due to external forces, was a challenge for Ferris and his fellow researchers.

“By eliminating outside factors, such as industrywide problems, we were able to identify those firms that really had no one or nothing else to blame but themselves,” Ferris said. “Firms that did admit the problem were able to stop the slide of their stock, and in many cases recovered within a year.”

Ferris stressed that recovering firms do more than just simply accepted the blame. They also had to explain how they were going to fix the problem.

Analyzing other factors, the researchers also found that the service length of board members, the number of directors, the independence of the board, and the structure of the administrative team did not have an effect on whether companies accepted responsibility for financial problems or tried to lay blame on external factors.

Ferris said several factors could be the cause of trying to lay blame on external forces, pointing to arrogance, pride, fear of litigation, and the inability of company leaders to see their own shortcomings. Of those companies that blamed external factors, 44 percent replaced their CEOs in the following year compared to only 32 percent of companies who accepted responsibility.

The study, “Poor Performance and the Value of Corporate Honesty,” will be published in an upcoming issue of the Journal of Corporate Finance.

Source: University of Missouri

Topics Missouri