Markets and the paradox of good results

Surprises in the stock market often defy expected logic. Even when a company outperforms analysts' projections, its share price may still fall. Why? A recent study co-authored by NEOMA researcher Maxine Yu shows that investors do not base their decisions on raw numbers alone: they weigh them against a company’s past performance, its competitors and — importantly — what they imagine will happen in the future.

It’s autumn 2024, and the pharmaceutical powerhouse Eli Lilly reports impressive third-quarter results: $11.4 billion in revenue, up 20% from the previous quarter. Remarkably, despite this strong performance, Eli Lilly’s stock tumbles 10%. And just days earlier, Meta had suffered a similar fate: after posting robust growth and exceeding analyst forecasts, the share price of Facebook's parent company fell by 4%!

The two scenarios are equally intriguing. In the popular imagination, the stock market follows a straightforward formula: strong performance drives prices up, weak results drag them down. But the truth is far more complex, as markets sometimes behave counterintuitively, penalising success and rewarding mediocrity. This paradox, far from trivial, lies at the heart of the work carried out by the NEOMA researcher and her colleagues, who conducted a detailed analysis of how investors react to announcements about financial results.

In the minds of investors

The research team turned to the theory of “expectation violation” in an attempt to make sense of this puzzle. This theory posits that it is not the raw results that count, but the gap between anticipated and actual outcomes.

The US stock market marches to the beat of a fixed calendar: the big firms publish their earnings every quarter, while an army of analysts races to predict the figures before they drop. These estimates, which are compiled by consensus, act as an official barometer of market expectations. When results exceed predictions, it’s a good surprise; when they don’t hit targets, it’s bad.

In practice, however, this line of reasoning does not tell the whole story. The study reveals that investors do not just listen to analysts: they add their own filters. They form their opinions by comparing a company’s past achievements, the performance of its competitors and their expectations of what it will be able to achieve in the future. In other words, a number is never assessed in isolation: it is situated within a framework of multiple benchmarks, where the past, present and future intersect.

This helps explain the paradox of the stock market: an increase in earnings may still disappoint investors if rival firms do better. Conversely, a modest result may spark enthusiasm if it signals more favourable prospects ahead.

Markets are guided by the future

Of all the criteria that investors use to make their decisions, the study shows the importance of anticipating the future. The researchers introduce the “prospective expectations” – that is, what a company might achieve going forward — as a new element that complements the more traditional benchmarks based on past performance and that of competitors. An update of these expectations, even in the absence of concrete information or data suggesting that future performance will deteriorate, can trigger negative investor reactions. So, a firm might post profits that outstrip forecasts and still be punished if it simultaneously announces a large-scale investment plan, an expensive restructuring or a strategy the market considers too risky. On the other hand, average results may attract the interest of investors if they point to the potential for sustainable growth.

Even more strikingly, these are not the reactions of amateur investors, but of veteran institutional players; in other words, high-volume capital managers such as retirement-focused pension funds, insurance companies, investment banks and state-backed sovereign funds. These institutions today control almost three-quarters of the world’s market value, and even the slightest movement has an immediate impact on the markets. 

Faced with the simultaneous management of hundreds — sometimes thousands — of securities, these managers often find it impossible to analyse each one in detail. To cope, they rely on cognitive shortcuts to sift through information and make on-the-spot decisions. As a result, even the most powerful figures in the world of finance (supposedly the most rational) can be influenced by factors that intensify reactions which, on the surface, appear irrational.

The stock market: a warped lens

It follows that it is not enough for companies to beat forecasts. Better insight into investor decision-making can help business leaders anticipate stock market reactions and adjust their financial communications accordingly.

As for investors, the study provides a key reminder: markets are not rational machines. Even the biggest institutional players resort to shortcuts that can unjustly penalise strong results. Recognising these biases also provides a pathway to sidestepping them.

In showing that financial responses are based on a complex layering of expectations, the study sheds light on a paradox well known to seasoned professionals. Markets don't just judge numbers; they also contextualise them. Behind the seemingly irrationality of market swings, it is the psychology of investors that emerges… reminding us that finance remains, at heart, a deeply human business.

Find out more

Yuri Mishina, Maxine Yu, and David Gomulya. “Woulda, Shoulda, Coulda? The Impact of Predictive, Prescriptive, and Prospective Expectations on Stakeholder Reactions”. Academy of Management Journal. https://doi.org/10.5465/amj.2024.0135