Introduction to Sandbagging
Sandbagging is the process of reducing the expectation of a company based on diminishing its strength and core competencies to generate a result that was above its expectation or what was actually anticipated for and this is primarily done by top management of a company to lower the expectation of its shareholders.
In sandbagging a company’s top management generally tend to issue lower guidance than what the actual scenario is to its shareholders. This means management purposely lowers the projected earnings and overall performance KPIs. During the consecutive period when the company shows a better picture or likes better than expected results, the investors and shareholders feel even more grateful and impressed with its performance considering the earlier scene where the company had sandbagged the profits. Thus it is more a deceptive strategy where top management of the companies lowers the expectations of the company, hides its profit earned, and portrays a gloomy picture to its shareholders.
How does it work?
Sandbagging is a strategy used by companies to prepare the expectation of their financial statement by shareholders and others involved with the business on a lower front where the company has performed well or outperformed its expectation. When during the consecutive period the company has made good business or met its objectives, to shareholders it looks like it has over-performed its expectations and thus it brings about joy to shareholders. Companies will utilize this strategy by taking control of investor expectations by making use of analyst reports, media-generated reports, and press releases. Thus by lowering the expectation of its shareholders the company will create a self-defined zone for itself where it depicts that it has lowered expectations but still outperformed in the next consecutive period which helps to gain shareholder confidence and increment in the share price of the company adding in the overall financial strength of the business. This is a very important strategy to prevent a sudden deviation in investor expectation which might affect the share price of a company and in return affect the overall financial health of the business too. It is not only used by established business but start-ups also apply this strategy. Here the newly formed company will show an understated result than what they have performed to attract investors after the announcement of actual result which will show that the company has outperformed its expectation. It is also applied in the field of merger and acquisition by implication of pro sandbagging clause which protects the right and interest of the purchaser or the acquirer.
Example of Sandbagging
Let us discuss a scenario, related to the stock price of a company. Companies, before they release their financial result for a period, make use of these techniques to control investor and shareholder emotion and expectation and thus bring about the fluctuation in the share price. Suppose a company has its financial report due to be released in few weeks and this is when it makes use of its in house analysts to make a forecast for the company in their reports stating that the company expects a stable growth based on its predicted earnings. In reality, the company has performed well and is supposed to have a double-digit profit and over-perform its set expectation. Thus in this way the company captures the sentiment of the shareholders who based on the analyst reports think the company had performed on a stable basis. Now when the actual result is announced the numbers in the financial statement show above-average growth and shareholders get impressed by this that the company has performed beyond what was expected. This leads to a sharp buy signal for the shares of the company with immediate growth in the share prices too. It is all about the public sentiment which drives the prices of the stock and in this way the company makes more money with greater market capitalization.
Application to Sandbagging
This finds its application in many fields of finance which is discussed below:
- Sandbagging in start-ups: A start-up will adhere to sandbagging to attract investors for future funding. Start-ups will use this method of sandbagging its profits by giving understated earning updates and estimates as to show they will achieve below than what was expected. However, when actual results are out it gives the impression that the company has outperformed its expectation and has gone beyond shareholder expectation. Start-ups will use this technique not only to gain the trust of existing shareholders but also to attract new potential investors to their business. When investors find the company outperforming its expectation constantly its shows interest in funding in that business perceiving it as a promising business opportunity.
- It in merger and acquisition deals: Every merger and acquisition deal will contain a pro sandbagging clause. This clause protects the interest of the purchaser or the acquirer where the merged or acquired company is bound to disclose all the information about the company correctly to the acquirer. In some cases, the seller may sandbag some information about the company and not disclose it all to the buyer or acquirer. This should have been disclosed but in some cases, the seller will deliberately sandbag or hide such information from the buyer or the acquirer. Thus under the pro sandbagging clause, the acquirer has the right to incur losses due to some information by the seller at the time when the deal was made. Thus even after closing the transaction if such sandbagging of information had occurred and the acquirer has made up loses the seller is bound to make up for such losses.
Sandbagging may be perceived as a very effective strategy but the usage of this strategy over a prolonged period can bring about a drastic effect on the company. Thus the usage of this strategy is limited and restricted over some time only. It is a very good strategy for start-ups because this can help them in gaining access to additional funds for investment and setting up or expansion of the business.
This is a guide to Sandbagging. Here we discuss an introduction to Sandbagging, how does it work with explanations, examples, and the application. You can also go through our other related articles to learn more –