The Role of CEO Trustworthiness in Stock Market Reactions to Earnings News

• In Event: DSFI Session 2

Abstract

Do facial appearance-based judgments predict real-world outcomes? Research in psychology, economics, and finance generally find that perceptions of appearance matter in predicting various outcomes such as compensation, lending rates, etc. We add to this stream of research by investigating whether and how CEOs’ perceived trustworthiness, based solely on their facial appearance, influences the extent to which stock market participants react to earnings announcements. We find that the stock market reacts less negatively to bad earnings news when it is coming from a trustworthy-looking manager. However, we do not find evidence that perceived trustworthiness matters in the stock market reaction to good earnings news. In addition, we find that the above results of a mitigated negative reaction to bad earnings news in the presence of trustworthy managers only hold when the level of uncertainty is high. This is consistent with the idea that perceived trustworthiness is particularly important during times of uncertainty or for firms with high uncertainty because of the increased difficulty for an investor to assess a firms’ prospects. Finally, consistent with prior work in this area, we find mixed evidence that firms with trustworthy-looking CEOs are indeed trustworthy. Specifically, we find trustworthy-looking CEOs have lower discretionary accruals, but they do not have lower Fscores or a lower likelihood of having an accounting irregularity. Taken together, our findings extend prior research by documenting that facial appearance-based judgments are also relevant in the capital market setting. Investors appear to “price” their impression of CEOs’ trustworthiness, particularly in the context of negative earnings news.

Authors

• Weili Ge, University of Washigton

• Dawn Matsumoto, University of Washington-Seattle

• Sarah Shonka, University of Washington-Seattle