Investor

When it comes to social responsibility, corporations are in a tough spot. Traditional financial theory holds that corporations exist in order to maximize profits for shareholders. To the extent they divert corporate resources to fund social or environmental causes unrelated to their business, it represents a transfer of wealth from shareholders to a different constituency.  Further, it is a transfer of wealth over which shareholders – the owners of the company –  have little or no say. This is troublesome because corporations do not exist to redistribute wealth.  To the extent that any institution exists to redistribute wealth, that role goes to governments.

This does not mean that corporations should not be concerned with the environment or the social context in which they operate. Rather, it means that corporations should be paying careful attention to those issues where they can have an impact and where the cost of ignoring them will have a detrimental effect on the company’s future prospects, image or share price.  Spending money to make a difference in environmental and social issues that are part of how they operate is an acceptable corporate expenditure.  Spending money to fund the chairman’s pet charity to save the Tibetan yak is usually not, unless you are in the business of mountain expeditions.

How does all of this fit into investor relations?  In my twenty-five years of talking to investors, it has been rare that major institutional investors raise these types of issues.  Institutional investors focus on your company’s future prospects, back-tested against your current performance.   Unless your company’s future prospects are being impacted by environmental or social issues, most investors don’t seem to care.  There are a few socially responsible investment firms, but I’ve never really seen them have much more than a gadfly effect.

So does this mean corporations should just ignore the issue?  You probably can, but I would hope not.  Your company is probably doing things that you can point to as responsible corporate citizenship. Most companies are constantly testing ways to save money by eliminating waste and inefficiencies.  The best of these ideas often result in both costs savings and benefits for the environment.  For example, every social activist’s favorite target, Wal-Mart, has done many such things. Here’s an illustration from the book The Wal-Mart Effect, by Charles Fishman: in the 1990s, Wal-Mart came to the conclusion that there was no need for deodorants to come in a separate box.  The cardboard box added cost, took up shelf space and required trees to be cut down to make the cardboard.  Yet the box didn’t add anything to the customer experience and surrounded what was already a perfectly good container.  So Wal-Mart worked with manufacturers to get rid of the boxes.  As a result, the product cost less to produce, some of which was passed along to consumers, and the environment benefited because the demand to cut down trees for cardboard was reduced.  (One can only hope that they are working on the same thing with respect to blister packs.)

Good companies undertake these types of projects all the time. A good investor relations practice is to make a list of all the projects your company does to eliminate waste and inefficiencies or to make the work environment safer.  The next time you’re questioned about your company’s commitment to the environment or social causes, pull out your list and discuss it along with the comment “Look, we can’t be all things to all people – our resources, just like everyone else’s, are limited. But we do choose to try and change things for the better where we can have an impact.”  Better yet, be proactive and talk about these things as part of your regular communications.

I am not enough of a Pollyanna to think that this will mollify activist investors with a militant agenda, but you’re not going to make them happy anyway.  The objective here is to have a well-reasoned response that shows you are influencing things to benefit your customers and the environment in which you operate.  And, like Wal-Mart, you probably shouldn’t expect to receive too much credit for what you do.  After all, as Kermit the frog said, “It’s not easy being green”.

Those that are involved in investor relations recognize that in order to do it right, you need to combine skills from the disciplines of finance, marketing, law and communications. Underpinning these disciplines are a deep understanding of the company you represent and knowledge of how the capital markets work. So there are a lot of factors at play. Combining these factors in a coherent message can be a tricky business, because if one chooses to emphasize one factor over another the entire message can suffer.

For example, if a press release is written where legal factors and accounting dominate, the result is a stilted document that reads like a regulatory filing, a lawyer’s brief or worse yet, an accountant’s statement. In other words, something that’s deathly dull and uses language to obfuscate rather than clarify. Similarly, if the marketing and communications disciplines dominate, what you wind up with is a document that is more hype than substance and is bound to turn off your audience of sophisticated investors. The key to getting the message right is to balance the various factors.

You start with the key message you wish to convey (communications). Then you consider your audience and how they may view and react to the information you are giving them (marketing). You bolster your message with a discussion of how the business operations either supported your message or will be impacted by the information you are conveying (finance). Finally, you run what you intend to say through the legal filters to make sure you are complying with the appropriate regulatory scheme (law).

One of the things I have learned from combing through business textbooks in preparing for my class on investor relations is that a catchy graphic helps to explain complex relationships. Couple that with the fact you almost can’t give a talk nowadays without PowerPoint slides and I simply had to create a graphic to illustrate this point. So here it is – my attempt at capturing the need to combine all four disciplines in your investor relations message.

Of course, it’s one thing to understand the theory, it’s another thing entirely when you are trying to incorporate comments to your press release by the CEO, CFO, the General Counsel, the outside auditors and the communications department.

This is where investor relations officers should think back to the Goldilocks story and say to themselves, “Not too much law, not too much marketing, but just right…”

It’s at times like that I recommend you pull out the graphic to remind yourself what it is you are trying to achieve.
 

When I teach or give a public talk, I like to bring in a variety of sources in order to keep the audience engaged (and also to prove the worth of my liberal arts education earned many years ago). I find that introducing something interesting, which, at first blush has no connection to the topic, helps to get people thinking about what you’re saying. Of course, sometimes it’s the only thing they remember from your talk, but I’m happy if they remember anything.

For example, a number of years ago I was given the task of explaining executive benefits at a 7:00 AM meeting. Talk about deathly dull topics at a time of day when most people are struggling to wake up. The strategy I hit upon to liven things up enough to keep people awake was to use song lyrics to illustrate my points. I had to work at it – not many songs mention stock options or long term disability insurance – and eventually references ranged from Gershwin to 1960s Motown to Pink Floyd, but I kept the audience interested in what I was saying.

I bring this up because one of the obscure references I like to mention when I discuss the role of communications in investor relations is Sisyphus. Those of you that were blessed with a proper grounding in Greek mythology will recall that Sisyphus was the Greek King who incurred the displeasure of Zeus and was sentenced to roll a huge boulder up a steep hill, only to have the boulder roll back down to the bottom of the hill before he arrived at the summit, forcing Sisyphus to begin all over again. This ceaseless effort very concisely describes the process of communications in investor relations.

When you are communicating with investors, as they used to say in an old Nike ad, “There is no finish line”. The company is constantly moving towards its next reporting date. You are either just reporting results or getting ready to report results. The company and its strategy are continually evolving, requiring you to refresh your message. The composition of your investor base is also routinely changing as the stock is bought and sold, causing you to have to regularly educate an entirely new set of investors. In short, it never stops.

Nor should it. Good investor relations requires continual communication with investors and potential investors. The more you communicate in a transparent manner, the fewer surprises will confront investors and the less volatile your stock will be. When more information that is routinely transmitted to the Street it also means that there is less opportunity for insider trading. In short, as in economics, more is generally better until you arrive at the point of disutility. What constitutes disutility of information is a discussion for another day. For now, I will leave you to roll the rock up the hill.

In marketing there is a well-known graph known as the Product Lifecycle Curve, which I’ve set out below.

The graph illustrates how successful products are first brought to market and purchased by early adopters, then go through phases of rapid takeoff and swift growth. Once the product has achieved wide spread acceptance, the growth begins to slows down, eventually reaching a period of maturity. Mature products run their course and inevitably decline sets in.

The speed at which all of this occurs depends in large part on the nature of the industry and the aggressiveness of competitors. Tech gadgets, for example, have much shorter product life cycles than say, breakfast cereals. The exact shape of the curve and the length of maturity will also differ, but the general shape and sequence of the curve holds true for many products.

The interesting thing about the product lifecycle is that it has applicability to a number of other things, corporate lifecycles included. Stop thinking about products and substitute corporate development and the graph doesn’t change. Where this is of interest to investor relations professionals is in the type of investors each phase of the cycle attracts. Set out below is the same graph with investor segments sketched in.

One of the interesting things about the graph is that as you move on the life cycle line from left to right, the price/earnings ratio that investors are willing to pay for a stock declines. This is because investors perceive that the rate at which future earnings will accrue to the company is slowing and they are therefore willing to pay less for that future stream of lessened earnings. Growth investors are well known for their penchant of “paying up” for future growth, while value investors are almost religious about not over paying for a stock.

Companies often struggle with this, particularly at the inflection points between stages. Company executives will say, “We’re a growth company – look at our past record. The market is undervaluing us.” Investors, on the other hand, will look forward and say, “Nope, you’re a mature company. Your big gains are over and we’re not going to pay a premium for a company that is going to grow at the rate of the market.” Many an antagonistic relationship has been fostered based on this differing view of the world.

Understanding where your company stands on the lifecycle graph can help an investor relations person understand how the street may be viewing you.

In academia, professors almost never express something in clear understandable prose when a jargon filled expression can be used. Hence, the title of today’s post. Pareto Principle is the fancy name academics give to the 80/20 rule; that is, that 80 percent of effects come from 20 percent of the causes, or to put it another way, the few (20 percent) are vital and many (80 percent) are of little consequence.

This comes into play in investor relations in two important ways. First, almost every investor relations department I know works with constrained budgets and limited staffs. As a result, they need to be efficient with their time and effort. (My personal theory for this is that IR usually reports to the Chief Financial Officer and not the V. P. of Marketing, but that a topic for another day.) Second, most companies today are 70% – 80% owned by institutional investors, and it is within this group that the 80/20 rule has effect. Plainly put, 80 percent of the shares in a company are usually held by the top 20 percent (or less) of the institutional shareholders. Therefore, in order to efficiently reach the maximum number of shares in your investor relations efforts, you need to give first priority to the top 20 percent of your institutional shareholders.

As an example, and in order to put some numbers on this theory, let’s say that a large company has 500 institutional shareholders and 100,000,000 shares outstanding. A typical investor relations staff cannot reach out and be in contact with 500 investors every quarter. There is usually not enough personnel and budget to get the job done. However, the 80/20 rule tells you that of the 500 institutional investors, 100 investors will control 80,000,000 of the 100,000,000 shares. One hundred investors is a much more manageable number for investor relations departments to stay in contact with.

It’s a simple marketing principle: Take care of your best customers. This is not to say that you violate disclosure practices in prioritizing your shareholders. Material, nonpublic information should always be released to all shareholders at the same time. Rather, these large investors should never be disappointed because you failed to regularly communicate with them regarding normal, nonmaterial voluntary disclosures. A good investor relations department will have standards for how often these shareholders should be “touched” and a tracking system to make sure they are being met.

When institutional investors make purchase and sale decisions regarding stock, it is often done in a complex, multiparty transaction involving sell side analysts, salesmen, buy side analysts, portfolio managers and traders, with information about the company being judged against a competing universe of offerings. Rare is the large institutional stock purchase that is originated and made by a single trader sitting in front of a screen.

More often the trade occurs along the following lines:

• Joe, a sell side analyst, publishes an analytic piece that sees a strong future for the widget industry. In order to promote his investment views on the widget industry Joe then goes on his firm’s morning call, a daily event that is broadcast out to his firm’s institutional sales force. On the morning call Joe will verbally summarize his investment thesis on the widget industry. Depending on the firm and how busy the morning call schedule is, Joe will have between 2 – 5 minutes to state his case.
• The next step in the process occurs when Bob, an institutional salesman for Joe’s firm, hears the morning call and decides that investing in the widget industry might be a timely investment decision for some of his sales clients who consist of institutional investors – mutual funds, investment advisors, pension funds and hedge funds. Bob earns his living by knowing the investing preferences of his clients and, while not all will be interested in the widget industry, there are several that might have an interest. He then begins to call these clients and pitch the idea, noting how the widget industry would fit with their current investment philosophy and mentioning the strong research track record of his firm’s analyst, Joe. Depending on the firm that he is calling, Bob may pitch his idea to either an analyst at a buy side firm, a portfolio manager at a buy side firm or people in similar positions at hedge funds. Usually the pitch lasts no more than 1 ½ – 2 minutes.
• In this case the investment idea resonates with Sally, an analyst at a buy side firm and she asks for a copy of the industry report. The report, which is 15 pages in length, details the reasons why widgets are poised to grow rapidly in the current economic environment and examines the prospects of the firms in the industry. Sally, who is the person in her firm responsible for covering the widget industry, then starts to do more in-depth research.

  Although she has had responsibility for coverage of the widget industry before reading the report, the widget industry is one of many she is responsible for and previously it may not have been a high priority for her. Alternatively, circumstances may have changed in the economy to make the industry more attractive from Sally’s viewpoint. Using the industry report as a base, Sally will now begin to do more investigation of the top two or three firms in the widget industry that fit her firm’s investment profile. This investigation may consist of calling up each company’s investor relations departments to get more detail on their management, business philosophy and strategy, speaking with Joe, the sell side analyst, soliciting the opinions of other sell side analysts, building detailed financial models, further research on the industry generally and speaking with industry sources and experts. When Sally feels she has accumulated enough information to formulate and back up a recommendation, she will propose the idea to her firm’s portfolio managers. The forum for this proposal will vary by firm and it might be made in a research meeting, a portfolio manager’s meeting or individually to selected managers Sally knows might be receptive to the idea.

  Often the portfolio managers will have additional questions that will entail either more research by Sally or more discussions, either by Sally or the portfolio manager, with Joe, the sell side analyst.

• Finally, after much analysis, Jane, the portfolio manager, will make a decision to purchase a quantity of shares in WidgeCo., a rising star in the widget industry and a company that fits with the growth orientation of her portfolio. In making this decision, Jane will have to decide how many shares to buy, keeping in mind her portfolio’s overall composition. She will also have to decide if shares of other companies in her portfolio need to be sold and if any rebalancing needs to be done to stay within her portfolio guidelines.
• Once the decision to buy is made, Jane will then call the trading desk at her firm and instruct Barry, the head trader, to execute the purchase and to do the trade through Joe’s (the sell side analyst) firm, so that commissions attributable to the trade will serve as compensation for the research idea that led to the investment decision.

In the foregoing events, there are several marketing fundamentals at play. Because of the length of this post, today we will discuss only the effect of decision complexity. Any time you have complexity in the way a purchase decision is made with lots of competing choices, the process takes a longer period of time to analyze the pertinent data and come to a decision. Rivel Research, a market research firm that specializes in studying investor relations issues, has stated in one of their studies on the buy side that it can take 3 – 5 “touches” with management before a purchase decision on a stock is made^[1]. I have personally known investors who took 4 – 5 years of following a company before they made a significant investment decision.

Because these complex purchase decisions require more upfront effort by all parties involved, marketing tells us that investor relations needs to be a relationship business. It is much harder to sell a product (your stock) if you do not have rapport with the customer. On the investor relations side of the fence, this means treating analysts fairly and consistently, helping them understand your company and industry, promptly returning phone calls and meeting requests, chasing down the details that help fill in the picture for the investor and eliminating some of the informational uncertainties that go with buying stocks. In short, performing all of the essentials of good customer service.