Academic Research Shows that Excessive Optimism Can Backfire

By Cydney Posner

We've all known, on an anecdotal basis, that including overly optimistic statements in press releases can be problematic, but here's a report about some academic research that supports that notion more systematically. The title of this article from CFO.com tells it all: "Upbeat Words in Earnings Statements Can Get You Sued, Research Shows."  According to the article, recent academic research shows that "companies that use overly optimistic language in earnings releases are 75% more likely to get sued after their stock performs poorly than companies that used more moderate language before a stock dip." The researchers compared 330 companies -- 165 companies that were sued for securities fraud involving material misrepresentations and omissions about the company's financial health and its future prospects, and 165 companies that were not sued, although they had similar characteristics and economic declines. The researchers concluded that the companies that were sued "had used more upbeat language in their earnings releases. ‘The results suggest that executives' optimistic language can result in them getting sued,'" according to an associate accounting professor at the University of Chicago. Words and phrases that appeared to be mentioned frequently in the litigation fillings were the term "strong," quotes by executives that they were "very pleased" with the company's historical results or reports that customer satisfaction scores were better than those of the competition.

To mitigate risk, the researchers suggest that managers limit their use of positive language and temper their optimism with statements that are less favorable. Although researchers do not contend that companies must eliminate optimism altogether, they do recommend that officials be truthful in their statements and circumspect in their tones. Companies should also make sure that company insiders are not selling their company stock in a way that would contradict any optimistic tone and help fuel arguments used in shareholder litigation.

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