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«Internal and External Attributions by Managers in Earnings Conference Calls by Zhenhua Chen Business Administration Duke University Date:_ Approved: ...»

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First, I focus on the implications of managerial attributions on earnings persistence and investor reactions while Li (2010) focuses on the implications on corporate policies. Li (2010) views self-serving attribution biases as one managerial trait that leads to CEO overconfidence about firms’ future performance and therefore optimistic corporate policies. My main research question is whether managerial attributions are self serving or not, and in turn whether they provide valuable information for investors to evaluate firm performance. Thus I study whether self-serving attributions are related to earnings persistence and how investors react to managerial attributions. Second, I focus on earnings conference calls while Li (2010) studies the MD&A parts of the 10-K filings.

There are distinct advantages to using earnings conference calls relative to MD&A. First, during the calls managers have interactive conversations with analysts while MD&A are pre-scripted texts disclosed after considerable deliberations. Bloomfield (2008) argues that linguistic properties such as word choice and sentence structure represent unconscious behaviors and thought processes. Annual reports are pre-scripted texts which may not have linguistic patterns similar to spontaneous conversations.

Conference calls contain conversations between managers and analysts which are largely spontaneous.1 Second, it is not clear that CEOs actually author the MD&A section because corporate textual disclosure is usually the collaboration of managers, auditors, lawyers and investor relation staff. Another advantage of conference calls is There are scripted presentations at the beginning of each conference call. However the questions and answer section of the conference call is less likely to be scripted and more likely to represent spontaneous conversations.

that we can observe CEOs presenting the financial results and interacting with financial analysts, thereby providing a direct context in which to observe managerial behavior.

Finally, this paper builds on recent work in accounting that examines the qualitative information of management disclosure. Early studies in corporate disclosure relied on the level of disclosure to examine the effects of disclosures (for example, Lang and Lundholm (1996)). More recent studies examine the linguistic tone (Davis et al. 2008;

Demers and Vega 2008; Engelberg 2008; Loughran and McDonald 2011) and other characteristics of corporate text like readability (Li 2008) and vividness (Hales et al.

2011). This study expands the set of qualitative information provided to market participants by investigating attributions.

The remainder of this study is organized as follows. Section 2 discusses prior research and develops the main hypothesis. Section 3 describes the research design and sample construction process. In section 4, I explain how I measure management attributions in the large sample. Section 5 conducts a series of tests to verify the construct validity of the attribution measure used in this study. Section 6 presents empirical evidence regarding how CEOs make attributions during conference calls.

Section 7 examines how the stock market and financial analysts react to CEO attributions. Section 8 shows how managers’ attributions are related to earnings persistence. Section 9 studies whether the stock market reaction is complete by examining the association between future stock returns and managers’ attributions.

Section 10 provides evidence about whether boards react to CEO attributions. I conduct additional empirical analysis in section 11, robustness tests in section 12, and I conclude in Section 13.

2. Related Research and Hypothesis Development Causal reasoning has been studied extensively in the psychology literature, and theory indicates that human beings search for causes of events in their everyday activities (Försterling 2001; Kelley 1992). For example, people frequently ask questions such as “Why did I do well in the midterm?" or “Why did we lose the basketball game?” Psychology research suggests that attributions to such questions help a person understand an event as well as to predict future outcomes. Moreover, understanding the causes of events enables a person to take action in order to control future events in some situations. For example, if a coach attributes the loss of a basketball game to internal factors such as game strategy or player ability, he/she may change strategy or spend time improving player ability. However, if he/she blames external factors such as an unfavorable referee or bad luck, he/she may not make any change in strategy or player development.

Understanding causal relations between performance drivers and corporate performance is important in business contexts. It is essential for managers and investors to correctly identify the underlying factors that affect firm performance. For managers, recognizing the correct performance driver helps them take corrective actions to improve future performance. Ittner and Larcker (2003) find that companies that establish a causal link between non-financial performance measures and financial outcomes experience higher ROA over a five-year period than other firms. Financial analysts and investors are also interested in identifying the factors that affect firm performance.

Understanding the nature of firm performance facilitates prediction of future earnings and improves investors’ resource allocation decisions. Prior research finds that CEOs often discuss performance drivers through various disclosure channels and management forecasts are commonly accompanied by managerial attributions (Baginski et al. 2000; Baginski et al. 2004).





Psychologists, like economists, usually assume human beings are rational when making attributions because humans attempt to obtain an accurate understanding of the causal factors of an event (Försterling 2001; Kelley 1967, 1992)1. However, a series of studies suggest that human attributions are sometimes biased and deviate from rational models (See Försterling 2001 and Koonce et al. 2011 for synopses of attribution biases).

One bias pertinent to this paper is asymmetric attributions for success and failure:

people tend to attribute good outcomes to internal factors, whereas bad outcomes are traced back to external factors (Beckman 1970; Johnson et al. 1964; Miller and Ross 1975).

In experiments conducted by Johnson et al. (1964), participants are asked to evaluate their teaching based on their students’ performance. The students’ scores are determined by the experimenter who withholds this information from experiment participants.

Results demonstrate that when student performance improves, the teachers are more Just as economists portray a perfect decision making person as an “economic person,” psychologists have a similar metaphor -- “naïve scientist” -- regarding how people make attributions (Forsterling 2001).

likely to attribute performance to their effective teaching. When student performance deteriorates, teachers are more likely to blame the quality of the students as the reason for poor student performance. In business contexts, a CEO can attribute a firm’s past performance to internal factors such as his/her own personal ability and the management team’s efforts, or ascribe it to external factors such as the macroeconomic environment and intense competition. If CEOs suffer from self-serving attribution bias, they will tend to attribute good firm performance to internal factors and poor firm performance to external factors.

Attribution bias is not the only factor that may influence CEO attributions.

Theory on effective leadership predicts that CEOs will make attributions in a manner opposite that predicted by the psychology literature discussed earlier (Collins 2001; Lee and Tiedens 2001; Lee et al. 2004; Morris et al. 2005; Ou 2011). Leadership theory argues that as leaders of organizations, CEOs can demonstrate leadership during the attribution process by deflecting praise when performance is good and taking blame when performance is poor. The notion of “humble servant leader” is not new to the leadership literature (Greenleaf 1977; Greenleaf and Spears 1998). More recently, Collins (2001) identifies personal humility as one of the two attributes of level 5 leadership2 in his bestLevel 5” refers to a five-level hierarchy of manager capabilities, with Level 5 at the top. According to Collins (2001), level 5 leadership is a mix of personal humility and professional will.

selling book, From Good to Great: Why Some Companies Make the Leap … and Others Don’t.3 The rationale behind this argument is that humility helps a CEO build a great team that will result in long term company success. Collins (2001) finds that “level 5 leaders” routinely credit others, external factors and good luck for good performance, and blame themselves when results are poor.4 Morris et al. (2005) argue that humility fosters a supportive relationship between managers and employees and socializes power, and therefore leads to organizational success. Ou (2011) suggests that humility helps CEOs empower leaders within the firms, promotes management team integration, and in turn improves job performance. From a survey of 63 CEOs, Ou (2011) finds that CEO humility is positively related to middle manager ambidexterity and job performance, suggesting that leadership-style attributions improve firms’ future performance.

Lee et al. (2004) make a similar assertion, although they only focus on the occurrences of negative events. They suggest that by claiming responsibility for bad news, managers convince investors that the firms are in control of the management. For example, Jeffery Immelt, the CEO of GE, attempted to convince investors that he can lead General Electric to continued growth following poor performance by telling the Featured as Best of Harvard Business Review 2001 and published in 35 languages, Good to Great has made a huge impact on leadership theory and practice (Caulkins 2008; Filbeck et al. 2010; Niendoft and Beck 2008).

Over three million copies of Good to Great have been sold. The book has been popular not only in the business world but also in not-for-profit sectors and business schools. Mike Useem, a Wharton professor, praises Good to Great as "the most significant book on leadership to appear in terms of moving how people think in the last decade." (See “Good to Great, a B-School Staple”, BusinessWeek online, January 19 2006) 4 Humility may also be perceived as a form of personal weakness, indicating lack of confidence and low selfregard (Exline and Geyer 2004; Tangney 2000). However, empirical evidence suggests that humility is clearly associated with confidence and leadership (Exline and Geyer 2004).

public that “I should have done more to anticipate the radical changes that occurred.”(Glader 2009) Overall, leadership theory suggests that CEOs make selfdisserving attributions relative to the self-serving attributions forwarded by psychology theory.

Given the fact that CEOs are both human beings and leaders, it is ultimately an empirical question as to which of the two contrasting theories of attributions is more descriptive of CEO behavior. Thus, my main research question is to examine which force

dominates on average, yielding the following hypothesis:

Ha (Attribution Theory): Managers attribute firm performance more to internal (external) factors when firm performance is favorable (unfavorable).

Hb (Leadership Theory): Managers attribute firm performance less to internal (external) factors when firm performance is favorable (unfavorable).

3. Research Design and Data Construction Prior studies (e.g.: Bettman and Weitz 1983; Staw et al. 1983) classify management attributions using human judges. The advantage of this approach is that humans are able to classify attributions with reasonable accuracy. For instance, Bettman and Weitz (1983) find that two independent judges agree on 94.6% of the attributions coded. A disadvantage of using human coding is that the analysis is not scalable, i.e., a large sample study is too costly. The small sample size potentially yields low powered tests of the determinants and consequences of management attributions, and hampers generalizability. To overcome these limitations, I adopt a new approach to measuring management attributions. Specifically, I measure the personal pronouns spoken by CEOs during earnings conference calls. I posit that more frequent usage of first-person pronouns represents more internal attributions and more frequent usage of third-person pronouns represents more external attributions. I discuss how I measure CEO usage of personal pronouns and test the validity of my measure in sections 4 and 5.

I consider the earnings conference call setting to measure attributions for several reasons. First, earnings conference calls are explicit avenues through which CEOs directly present and explain firm performance. In contrast, other corporate communications such as annual reports and SEC filings are often influenced by several parties including the firms’ attorneys (Choudhary et al. 2012; Hopkins et al. 2012).

Second, Bloomfield (2008) argues that many underlying theories in psychology rely on the assumption that conversations are spontaneous, which is not true for most firm disclosures. Conference calls include both presentation sections during which managers read pre-scripted statements and Q&A sections during which managers answer questions from analysts. Examining both portions of the call allows me to directly examine the validity of Bloomfield’s (2008) argument. Third, an earnings conference call is an important avenue for firms to provide voluntary disclosures, and prior research shows that such disclosures are informative to financial analysts and investors (Bowen et al. 2002; Frankel et al. 1999). By examining how managers make attributions, and how market participations react to management attributions, I am able to expand on prior research to more fully characterize what can be learned from earnings conference calls.

My sample selection starts with quarterly earnings conference call transcript data obtained from the Thomson Financial’s StreetEvents database over the period 2002 to

2007. From this sample, I eliminate conference calls where a CEO is not present or where more than one CEO is present1.



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