Sandbagging – How Companies Can Manipulate Forward Guidance

What Is Sandbagging in Business and Finance?

SandbaggingSandbagging is a strategy of lowering the expectations of a company in order to appear to produce greater-than-anticipated results.  In a business context, sandbagging is most often seen when a company’s top executives manage the expectations of shareholders.  They do this by providing guidance that is well below what they know will be realistically achievable. In other words, management will purposely low-ball projected earnings and other performance indicators.  As a result, the company achieves better-than-expected results and investors are significantly more impressed.  Psychologically, it is better to over-deliver on mediocre guidance than to just meet average expectations.

Sandbagging occurs when a company intentionally lowers its estimation for success with the goal of producing greater than expected results.  When the expected results are surpassed, the company will be seen as financially savvy.  The top employees may even receive a bonus in appreciation of their good performance.

  • Business managers may engage in this practice as a way of reducing the expectations of shareholders and investors.  They know very well that they will ultimately exceed those expectations.
  • Employees may also engage in the practice with the aim of being viewed as outstanding performers and receiving positive reviews.
  • Individuals often avoid setting realistic expectations.  They set lower expectations and then over-deliver to be viewed as above-average performers.

How Sandbagging Works 

Sandbagging is commonplace in the world of forwarding guidance.  Particularly, when it comes to the declaration of expected revenues and earnings. However, over time, the response of investors will become harder to manipulate.  This is because investors are becoming more sophisticated and aware of this practice.  As a result, they are less reactionary and take these announcements at strictly face value.

The underlying idea behind sandbagging is to underpromise and overdeliver. When management succeeds in keeping the company’s or investor’s expectations low, they can easily surpass the expectations. Senior managers sandbag by providing earnings expectations to analysts below what they believe they will actually achieve. Keeping expectations low can help the company maintain its current stock price.  But, sandbagging can poise the stock for a positive bounce once earnings are actually reported.  Let’s say XYZ Company provides reasonably high earnings estimates for the coming quarter, but below what they think they will achieve.  When the results are released and they are higher than expected, the company benefits in a number of subtle ways.  Their image will improve, there will be increased positive media coverage and the stock is poised to trend upward.

Sandbagging can Backfire

Sandbagging can be viewed as a sign of disrespect in certain circles, and so those who attempt it should be aware of the potentially confrontational ramifications of their actions….In some cases, sandbagging backfires because investors call the bluff of those doing the sandbagging and, consequently, anticipate the outperformance that the sandbaggers were attempting to cloak. Because of this, sometimes a stock price falls because earnings failed to exceed expectations by the amounts investors had expected. (Source:investopedia)

Example of Sandbagging Corporate Guidance 

Imagine that SandCo has a reputation for providing solid earnings estimates on its quarterly guidance.  The company’s guidance is usually accurate and consistent.  During the last quarter, the company declared that it was likely to post modest growth in sales and earnings. As a result, analysts are confident that the upcoming quarterly numbers will be uneventful. But when results were released, they are higher than the guidance estimate.  This results in analyst upgrades and positive press coverage.

Now imagine a similar scenario, but with a company that has a reputation for sandbagging. Nobody pays much attention to the modest guidance estimates.  When the actual earnings are released, the stock price would likely be largely unaffected by the better-than-expected quarterly results. The takeaway from these two examples is that sandbagging has a limited effect when it is overly employed because investors are quick to catch on to this practice. (Source:ibid)

Sandbagging a Startup Venture

When launching a new business, executives may hide the company’s actual potential growth and profit projections.  With no prior track record, the goal is to produce better than expected results for investors. Especially with a new business, the shareholders are eager to see how management performs.  This will help them decide if they want to continue funding the business in the future. The company can manage these expectations by giving earnings estimates below what they project to achieve. Once the results are attained and surpassed, the company and its executives will look more promising than expected to shareholders.

The problem with engaging in this practice is that it will be difficult to maintain over time. As the company outperforms its expected results period after period, investors and shareholders will adjust their expectations accordingly without focusing on what the company announces as the expected results. Continuing with this practice will be expensive for the company, and the stakeholders will come to find out at some point.

A startup may engage in this practice as a way of gaining an advantage in future negotiations. As a new entrant in a competitive market, the company will attempt to gain the trust of the shareholders and potential investors. Once it over-delivers on its expected results for several periods, the company will attract more investors looking to invest their funds in small but promising businesses. Also, it will be easy to retain existing shareholders who will be banking on the firm’s increasing profitability to grow their share values. (Source:corporatefinanceinstitute)

Sandbagging in Asset Purchases 

Sandbagging also occurs during an asset purchase or stock purchase agreement. In the sale of a business, the seller is expected to provide accurate information about the item on sale.  This is essential as the information is used in setting the price. However, the seller may knowingly or unknowingly exclude necessary information that is required to be disclosed to the buyer. However, the buyer can identify errors and omissions in the seller’s representatives and warranties, and still go ahead with the purchase.

The buyer can sandbag the seller using the errors/omissions in the reps and warranties as a basis for seeking an indemnity claim against the seller after the closing of the deal.  A seller should be on the lookout for a sandbagging clause in the purchase and sale agreement that sets the stage for the buyer to deliver an indemnity claim even when the buyer was fully aware of the inaccuracy before closing the deal. The seller can start by knowing the buyer’s reputation in previous acquisitions by talking to business owners who have sold their businesses to the prospective buyer. Also, the seller must examine the first draft of the purchase and sale agreement to identify clauses that give the buyer an undue advantage. (Source:Ibid)

Sandbagging Sales Numbers 

Sandbagging is common among sales staff who are eager to meet their weekly, monthly, and annual targets.  Many companies pay their sales team on a commission basis.  However, the practice motivates them to underpromise and overdeliver.  The goal is to increase the number of commissions and bonuses. For example, if the company sets a quota, an employee may lower the goal so that the quota becomes easy to achieve and surpass.

Once the employee’s reached his/her target for the month, they may keep the extra sales and move them to the following month when the sales may be slow.  Although sandbagging helps sales staff earn extra bonuses, it may prevent them from realizing their full potential. By lowering their expectations, sales staff can only perform within a certain limit that helps them achieve high results period after period while avoiding pressure from the manager. For example, an employee can indicate that he can get 5% more sales in the next quarter, while he actually knows he can manage 10% more sales. (Source:Ibid)

Other Contexts

The phenomenon of sandbagging isn’t restricted to earnings guidance reports delivered by publicly-traded companies. It is also used in recreational activities where betting is frequently involved. Sandbagging is the unethical practice of keeping one’s skill level lower than it should be by underperforming or even by losing on purpose. For example, a recreational golfer may deliberately shoot a game poorly, when he encounters a new player, who is unaware of his actual skills. This might entice the new player to accept bigger betting stakes.

  • Poker – Sandbagging in poker occurs when a player attempts to make it look like his or her cards are weak when they’re actually strong. The player does this by either checking or making a small bet in the open.  This indicates a hand that’s possibly weaker than the other players. The purpose of sandbagging is to goad opponents into betting more than they would if they believed the sandbagging player had a strong hand.
  • Golf – A sandbagger is a derogatory term applied to golfers who cheat by pretending to be worse than they really are. A golf bet often begins with one golfer asking another what their handicap is, or how many strokes do they get.  A sandbagger will misrepresent his playing ability, often claiming to be worse than he really is.  This is in order to get more strokes than he deserves.
  • Racing – Sandbagging is purposely giving less than 100% in order to mislead your competition and give yourself an advantage.  In drag racing, drivers will usually sandbag when there’s a bet on the race, especially when doing a best of 3 or best of 5 series. The goal is to appear like you’re giving your all when in actuality you are holding back for the last race.

Final Words

Sandbagging describes a strategy of low-balling the expectations of a company or an individual’s strengths and core competencies.  The goal is that even modestly positive gains take on greater weight.  In investing, sandbagging is most often seen when a company’s management issues earning’s guidance.  This guidance is below what they can realistically expect to achieve.  Sandbagging also applies to sports and recreational activities.  For example when a golfer deliberately shoots a game poorly to raise his handicap.

Up Next: What Is Accumulated Depreciation?

Accumulated depreciation is the total amount of depreciation expense written off against an asset from the time it was put into service. Put another way, it is the cumulative value of an asset up to a single point in its expected life as it is used up. Accumulated depreciation is a contra asset account.  This means its natural place on the balance sheet is a credit.  It reduces the overall asset value which is recorded as a debit. Unlike a normal asset account, a credit to a contra-asset account increases its value while a debit decreases its value. Whenever depreciation expense is recorded for an organization, the same amount is also credited to the accumulated depreciation account.  This allows the company to show both the cost of the asset and the total depreciation of the asset. It also records the asset’s net book value on the balance sheet.

Depreciation is recorded to capture the cost of using a long-term capital asset with the benefit gained from its use over time.  Accumulated depreciation is the sum of all recorded depreciation on an asset to a specific date. Accumulated depreciation is listed on the balance sheet just below the related capital asset line.  The carrying value of an asset is its historical cost minus accumulated depreciation.

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