Why Do People Evade Negative Information?

One of the questions I’ve always wondered in my career is why do some people in business evade negative information? 

I saw this repeatedly in my professional career: A banker would want to “get a deal done” and completely ignore bringing up bad information in their writeup or deflecting any discussion about it. A business broker would write up a glossy sale package for a company and intentionally omit information that could reduce valuation or deter a deal. Someone in a corporate office would refuse to discuss the negative consequences of a decision. Leadership would develop a key performance metric then suddenly stop talking about it when they realized it exposed a problem that would be uncomfortable to address.

“You can evade reality, but you cannot evade the consequences of evading reality”

What drives this behavior?  

Is evading negative information normal? Perhaps an error of omission gets more leniency than direct dishonesty. I’ve heard this referred to as the “clown vs. crook” defense in business: People claim “I didn’t know”, which is more acceptable than “I did know and intentionally misled you”. This can persist because it is challenging to prove what is known when.  

I struggled with two questions when I was working in my career when evaluating people and situations:  

At what point does non-disclosure or evading negative information become a character issue?   

When does a culture of evading negative information take hold? What is that tipping point? I’ve observed leaders that evade negative information surrounded themselves with people who also evade negative information.  

I didn’t expect questions like this to return after I left my career, but I’ve found myself thinking about this thanks to two of my individual stock investments:

Example #1: I’m invested in a few Real Estate Investment Trusts. Due to the challenges of the current pandemic, almost every REIT has started reporting monthly rent collections to investors. Real estate is experiencing challenges and some tenants are not able to pay rent. In this environment, it’s important to quickly evaluate the quality of commercial tenants and the best evaluation is “did they pay last month?” instead “can they pay” or “will they pay”.

Out of the handful of REITs I own, there is one that stands out for not reporting this number monthly. I know the number is bad, the type of properties they own mean their tenants are struggling. What is the point of withholding this information? Are they hoping to polish it up and wait for a quarterly report to talk about other metrics that don’t involve cash collected this month? The investors are not ignorant. The share price is down 68% this year and dividends are suspended. What is the benefit of avoiding this bad information at this point instead of being more transparent with investors? If the company isn’t having these disclosures externally, what are the discussions like internally? Is there a larger cultural issue of evading negative information?

Example #2: I’ve been a long time investor in a restaurant chain, it was undervalued and management completed a nice turnaround and I was rewarded as a shareholder. The growth from this turnaround eventually slowed and so did the company’s stock price. It was still a good investment, the company was paying a solid dividend, ran a conservative balance sheet, and was rewarding investors with a special dividend annually while recently announcing a stock buyback plan.  

Then in the middle of last year, the company made a curious acquisition: 1/5th of the company’s total equity was invested for a roughly 50% stake in an unrelated business. The joint venture was private and there was minimal financial disclosure, only speaking of “growth opportunities” and “millennial/gen-z excitement” over the concept. They did say the acquisition wouldn’t immediately be accretive to earnings due to growth and investments required.  

This entity had to be consolidated per GAAP and then started posting it’s quarterly earnings calls with losses in this consolidated subsidiary. Analysts would ask pointed questions and get partial answers. News was coming out about recently opened locations closing and a major investor made some rumblings about wanting more disclosure. The questions were deflected and promised to be answered at a mid year analyst day. 

Unfortunately due to the pandemic, this entire investment was written off in March, wiping out 1/5th of the company’s book value. The press release called the events “unfortunate” and “unforeseen”. The analyst day was also cancelled. I followed up a few times with investor relations asking for disclosures around the acquisition, specifically generally accepted metrics such as the valuation to total EBITDA and per unit EBITDA for locations open greater than twelve months. No luck: I guess if they aren’t going to give a nearly 10% shareholder disclosure, my few hundred shares really don’t matter. The company is declining me and all other shareholders the ability to evaluate a critical question: Was this a good decision with a bad outcome, or was the original decision flawed?  

I’ve now sold most of my position, but am left with questions: What is the consequence of leadership running from disclosure? Analysts have lowered price targets. Shareholders like me have suffered, the company’s valuation is around 2/3rds of what it was before this acquisition. At what point is this about trust? Lack of disclosure can only lead me to believe the worst. What caused a board of directors to unanimously decide this is acceptable? Was this a nine figure investment with a non-disclosure agreement on the acquired company’s financials? If so, why?  

There has been minimal management and board turnover since this acquisition was made. Maybe they are hoping to get a pass due to COVID, but how much trust did they lose with investors? Will they always trade at a discount to their peers due to their actions? Is there a bigger cultural issue that will prevent talent from working there? The answers to these questions may expose themselves over time.  

This left me with some thoughts I’d like to get feedback on:

How do you foster a culture of openness instead of one that evades negative information?

At what point do you think it’s a character issue to not discuss/disclose negative information in regular interactions?  

Is it ever okay not to disclose negative information?  

Where is the line between legal vs. ethical vs. moral decisions as it relates to the disclosure of information? The public companies are disclosing the minimum required by law, but is that enough?

What situations in business have a higher moral and ethical threshold for disclosure vs the legal requirements for disclosure?

Admitting a mistake is tough, especially at high levels in business. What happens when egos hide behind minimum disclosure verses doing what’s right for all stakeholders?  

Robert Chase spent nearly two decades in commercial banking and now provides deal evaluation, due diligence, and transaction advice for companies and limited partners.