November 02, 2006
Puffery and Executive Credibility
Posted by Lisa Fairfax

Today we covered “puffery” in my Securities Regulation class, which is the notion that statements of corporate optimism in the face of a corporation’s seeming financial distress are not viewed as actionable misstatements because investors expect actors to be overly optimistic and “look on the bright side.”

I have always been troubled by this doctrine, and what it implies about the trustworthiness of corporate executives and directors. Intuitively it makes sense that you would expect officers and directors to project an image of confidence and optimism, particularly when the company may not be doing well. Indeed, studies suggest that officers of major corporations tend to be overly optimistic—it is one of the traits that apparently makes them successful.

My concern is that such a doctrine encourages investors to continually second-guess corporate statements, thereby encouraging a climate of distrust between investors and corporate actors. Thus, when I asked my students what they felt about the doctrine, most of them seemed to accept the puffery doctrine because it confirmed their impression that “executives lie.” To that end, the puffery doctrine facilitates a (growing) distrust of corporate executives.

I am also concerned about its impact on executives. Executives already tend to be overly optimistic. And at the very least, that optimism could lead them to turn a blind eye to the truth—we certainly see threads of this notion in the recent corporate scandals. The problem is that there is a fine balance. We certainly want executives to exude confidence, but we also want them to be able to provide a truthful and realistic assessment of their corporate environment. It is not clear that the puffery doctrine facilities the right balance.

In the end, I always tell my students that the puffery doctrine is like a used car salesman defense—that is, executive statements of optimism should be considered in the same light as statements made by used car salesmen. And who actually believes what a used car salesman has to say? Indeed, several surveys have suggested that used car salesmen represent the least trusted profession. If this analogy is accurate, the puffery doctrine suggests that corporate executives merit the same level of trust as used care salesmen. I find that troubling.

Business Ethics, Corporate Governance, Securities | Bookmark

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Comments (5)

1. Posted by Kaimi Wenger on November 3, 2006 @ 15:17 | Permalink

Lisa,

On this topic, I particularly like Dave Hoffman's recent puffery piece, at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=887720 . He sets out a pretty good argument against how puffery is currently used.

In my opinion, the best arguments in favor of keeping the puffery doctrine around are damages arguments. It's the idea that if I say, "XYZ Corp. is the best company ever and our products rock," none of the big institutional investors will really think that means anything, and so it won't have any effect on market price. And so, "second quarter sales are expected to rise 20%" or "oil fields? what oil fields?" are material because they affect the share price. "Our products rock" doesn't do that.

To that extent, puffery merely reflects market reality.

On the other hand, I think it tends to get used much too broadly. And there are enough gray areas, that the used-car calesman dynamic really starts to matter.

If _some_ investors treat the statement as meaningful, and _other_ investors treat it as hot air, then the court is making a value judgment in choosing which investors' view to validate. When a statement is tossed as puffery, it validates the cynical.


2. Posted by Jake on November 3, 2006 @ 20:15 | Permalink

The puffery doctrine also has a ratcheting effect.

CEO/CFO in economic downcycle: "The company is presently the victim of macroeconomic, political, or social forces outside our control. But we are working tirelessly on behalf of you, the investors, to surmount this challenge. Pay up."

CEO/CFO in economic upcycle: "We are geniuses. Pay up."

Pick any public company that has been around for a few business cycles. Read and compare the MD&A in their 10-Ks over the ups and downs. What emerges, more or less, is the illustration above.


3. Posted by Brett McDonnell on November 4, 2006 @ 10:47 | Permalink

I share the concerns, but let me put in two arguments in favor of the puffery defense that are worth considering. First, sometimes corporate statements have as their primary audience someone other than investors. That, I think, is part of what is going on with Posner's opinion in the Eisenstadt case--the statements in question were in part aimed at potential bidders in the auction process that was at issue in the case. It may be in the company's interest to have some puffery aimed at outside parties.

Second, some degree of investor distrust of company statements may actually be a good thing. One problem that very strong, visible enforcement of the anti-fraud rules may create is that of too much trust on the part of investors. Let's admit it, no matter how well the laws are working, there will be plenty of misleading statements out there. Investors need to remain on their guard. Maybe the puffery doctrine helps reinforce a healthy degree of distrust.


4. Posted by Lisa Fairfax on November 7, 2006 @ 9:45 | Permalink

Kaimi, thanks for the reference. I have seem some pretty good papers on puffery including one by Jennifer O'Hare at Villanova. Brett, I must say that I am not sure about the first argument in favor of puffery--that is I see what puffery could be aimed at other parties, but wonder how we strike the right balance when the impact is felt by everyone in the market-place. However, I like your second argument--the puffery defense puts investors on notice that they should be both skeptical and diligent. But I wonder how you draw the line between healthy skepticism and outright distrust of corporate officers as a group.


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