Advanced Earnings-Call Research

Really Righting The Governance Balance

Back in November, your editor made a special point to attend a seminar on “Cognitive and Emotion Analysis of Management Representations” - given before a joint meeting of the New York Society of Security Analysts and NIRI-NY by Joel Litman, a managing director of Valens Securities, and quite an impressive fellow.

Aside from being a former managing director at firms like Credit Suisse, Diamond Technology Partners (now PwC) and Deloitte Consulting, Joel, a CPA who initially specialized in ‘forensic audits’ has taught or guest lectured on this subject at Harvard Business School, University of Chicago, MIT Sloan and Wharton.

And what an eye-opener the seminar was – both for writers, vetters and deliverers of earnings-calls and other management presentations – and for investors.

There are three basic methodologies to detect what Joel prefers to call “highly questionable statements” rather than outright “lies”… But hey, we say – if the CEO seems to be making a lot of “highly questionable statements” per speech – and on important
topics – that sure sounds to us like grounds to sell out – or to quickly sell short:

The first and oldest set of tools are “Visual, Non- Verbal Signals” - based on “facial motion detection’ and other signals like ‘big
non-verbal gestures’ and other tics, that are very much like the “tells” that savvy pokerplayers have been using to their financial advantage for years and years. (As Joel spoke, we thought of our own favorite ‘teller’ and tic-er, Richard Nixon, who always rolled his eyes skyward when he told a really big lie – to see if his good Quaker mother might be watching from heaven, as our rock-ribbed Republican family opined with horror.)

The next set of tells are linguistic ones: People issuing highly questionable statements tend to use a lot more words than necessary…and to use “distancing words” – like “That woman” – to use Joel’s example and to cite yet another president – and to use a lot of extreme words and superlatives – like “the best” or “the biggest and best.” Research shows that all of these verbal tics correlate highly with later financial restatements.

Another big linguistic clue, he says, is the lack of references to “shareholder value” at companies that ‘practice to deceive’.

The first two methodologies are the most complicated to learn and to apply – and pale by comparison to “Audio Analysis” which Joel said is the most objective by far, the hardest to thwart, the easiest to interpret…and developed by the Mossad, to boot.

Basically, he and his firm take a recording of an earnings call or any other management presentation, strip away all the extraneous background noise, and create an “Electro-Audiogram” of the speech that looks and works pretty much like the printout from a lie detector. Many of these audiograms tend to bear out the old saying that people tell about three lies every ten minutes, Joel says - but most of these “lies” are “social smoothing devices” that are easily identified and basically immaterial to an investor. Other common blips on the deceptiondetection scale arise from things that are “knowable, but basically unknown” to the speaker - or where the speaker has a low level of personal knowledge about or confidence in the subject matter, or in the ‘facts’ he or she has been given – like forward looking economic predictions and projections.

But if one sees “big deception markers” in connection with issues where the speaker is virtually certain to know the correct information, which Joel calls “super-knowns” – or should know it if he or she does not – it is a MAJOR red-flag. So, as Joel pointed out, knowing the context – and the company – and their business, and its key drivers – are very important elements in terms of
evaluating the deception markers, and just how large a warning sign they may be providing.

Who is using information like this? A list of companies where Joel has given speeches and conducted seminars - like CalPERS,Fidelity, AON, HSBC and Oracle – provides a hint. But the biggest users – and potentially the biggest winners here are hedge funds and other “strategic investors” with large long or short positions in a given security.

Perhaps the greatest and least expected take-away from the seminar is this: “Electro-Audiograms are better truth detectors than lie detectors.” Just as they show evidence of ‘deception” the audiograms can also reveal what Joel called “Excited Confidence Markers” which, when exhibited by the CEO, might, for example, prompt a spooky short-seller to close out a big position – or even to go long.

“We have been pretty much aware that folks like you have been doing what you are doing with earnings calls and other senior management presentations for quite some time” we commented after the program. “And it seems to us that most IR people, and many CEOs one would think, are at least somewhat aware of this too. How come more companies aren’t taking more care to minimize ‘deception markers’ that can so easily be spotted… like maybe vetting the speeches more carefully, deleting subject matter where confidence is low, leaving out, or maybe saying, ‘no comment’ or “We’ll get back to you on that” if potentially tricky
subjects come up – and certainly not intentionally deceiving listeners where the stakes are so high?

“And what about Directors? Wouldn’t a board that suspected the CEO of consistently overstating the positives think about commissioning an Electro-Analysis?”

“I think that hubris may play a big role here” Joel responded…”I’m not at all sure that very senior executives pay a lot of attention to what IR, PR and Governance people – or even directors tell them.”