Winning Investors Over. Baruch Lev

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СКАЧАТЬ of change swinging too far. Perhaps it already has.

      Regaining investors’ and the public’s confidence is the most critical issue facing corporate executives in the early twenty-first century. How else will they be able to secure investors’ and lenders’ backing for investments in growth (R&D, IT, brands), corporate restructurings, or strategic shifts? How else will they fend off disruptive activist investors and trial lawyers? For managers, it’s about protecting the core of their businesses—not to mention their jobs.

      Alas, there is no magic bullet here, no quick PR fix. Rebuilding confidence requires a concerted effort to repair relations with investors and the public: improve the quality and integrity of financial disclosure, restructure managerial compensation systems and governance design, and rethink corporate social responsibility. And above all, root out earnings manipulation, compensation abuses, false promises and hype, and self-serving managerial activities. These issues are what this book is about.

      This book is a survival kit, outlining systematically the way managers can regain and sustain investors’ confidence. Drawing on voluminous state-of-the-art research in finance, economics, accounting, and management, and plugging numerous knowledge gaps with my own research conducted for this book, I analyze a broad spectrum of issues and strategies related to managers’ interaction with capital markets, along with the consequences of such interaction, leading to practical actions. This comprehensive evidence-based approach focuses on proactive policies—how to avoid disappointing investors—as well as reactive actions—what to do when bad things happen. This, then, provides the basis for the specific actions—“operating instructions”—I prescribe at the end of each chapter, building up to the comprehensive capital markets strategy presented in the final chapter. While this book is primarily aimed at corporate managers, the wide scope of evidence and experience of what works and doesn’t work in capital markets, laid out next, will also be of great interest to investors, financial analysts, and business students, as well as to the business-minded public.

      The Critical Role of Capital Markets

      I have recently analyzed, with a group of doctoral students, the detailed transcripts of hundreds of quarterly earnings conference calls of managers with investors and analysts. As this book unfolds, I will share with you what I learned from this fascinating, albeit laborious (that’s where the students come in handy), endeavor. One startling observation: with but one exception, all the conference calls, lasting about two hours each, were conducted by the CEO along with the CFO—sometimes with other executives present—and watched over, of course, by legal counsel. These are not special events, mind you. Conference calls, made soon after the release of quarterly results, have been, in recent years, routine events, yet the top corporate guns conducted them all.

      Can you think of another corporate activity that is never delegated? Subordinates usually make crucial production, investment, marketing, or R&D decisions, and important relations with legislators and governmental institutions are often assigned to lobbyists. Talking to investors, in contrast, obviously cannot be entrusted to underlings. And, come to think of it, for good reason.

      The capital markets arena is where the success or failure of public companies is largely determined: the company’s cost of capital—the all-important price and, often, the availability of external funds to finance investment and growth—is determined in the capital markets, based on the information available to investors.² Share prices—the outcome of investors’ expectations and trades—directly affect managers’ compensation and increasingly their tenure: research consistently shows that poor share performance significantly increases the likelihood of top managers’ termination.³ Moreover, investor discontent, sparked by disappointing news and chronically depressed equity values, is the prime trigger for activist shareholders: Carl Icahn at Motorola, Nelson Peltz at Cadbury Schweppes, Eric Knight targeting HSBC Bank, Steel Partners at Japanese beer maker Sapporo, Ralph Whitworth at Sprint Nextel, and CalPERS, the giant California pension fund targeting multiple companies each year, are but a few examples of shareholder activists intruding in recent years on managerial turf, primarily because of share underperformance.⁴ And when investor discontent persists, a takeover and managerial overhaul ensues. Not the least of the adverse consequences of dropping stock prices are the consequent class-action lawsuits filed against managers and board members. All serious consequences indeed.

      Less appreciated, yet equally important is the fact that share price patterns—growth or decline—are a beacon for highly qualified employees to join, stay, or leave the organization. The “war for talent” is fought partially with stock. Google’s spectacular stock price rise from 2005 to 2007 facilitated its raids on top software engineers and programmers employed by stock-price-lagging technology companies, including mighty Microsoft and Intel, while Google’s subsequent price decline from 2008 to 2009 contributed to its own brain drain. And Morgan Stanley’s mediocre performance from 2004 to 2005 was a major reason for the defection of top banking talent to competitors.

      While capital markets affect the fortunes of all public enterprises, they are most crucial to the survival and growth of “equity-dependent companies,” those young, small and midsize, earnings- and cash-flow-starved businesses that nevertheless have attractive investment opportunities. These are high-tech, biotech, Internet–based, and health-care companies, as well as entrepreneurial transportation, telecommunications, and energy companies. They all rely on capital markets to fund their investment and growth.⁵ Downcast investors’ perceptions and lethargic stock performance are particularly damaging to these companies, which are vital to the nation’s economic growth.

      No company is immune to the vagaries of the capital market. Even if it doesn’t rely on the stock market for continuous fund-raising—having no plans for stock or bond issues in the foreseeable future—the performance of the company’s shares, lagging or leading comparable firms, is an influential operating and solvency signal to lenders, suppliers, and customers, affecting their relations with the company. Suppliers are known, for example, to restrict sales and credit to retailers with depressed share prices. No wonder, then, that interaction with investors, such as in conference calls, is invariably conducted by the Cs: CEO and CFO.

      Ephemeral Growth and Investors’ Discontent

      It’s all well and good as long as managers report profits and growth—increasing sales, earnings, and margins, beating analysts’ consensus forecasts—and predict a bright future. But practically every growth company sooner or later sees its core businesses mature and ultimately decline, and rejuvenating the growth so craved by investors is difficult. For doubters, the investment research firm Morningstar demonstrates how ephemeral growth is.⁶ Out of 2,179 public companies that had a one-year rise in earnings-per-share (EPS), only 41 percent saw their EPS increase over three consecutive years, and for five-year running growth, the number dwindles to 16 percent. Only 67 companies of the original 2,179—a mere 3 percent—reported EPS increases for ten years running. These sobering findings concerning the transitory nature of corporate growth are corroborated by comprehensive empirical research.⁷

      The picture is even bleaker for corporate performance tracked by free cash flows (operating cash flows minus capital expenditures). Of the 1,787 companies in Morningstar’s study with a one-year free cash flow growth, only 3 percent managed to report five-year running increases of this widely used performance indicator, and for ten years the number of consistent enhancers of free cash flow is virtually nil. If you wonder why cash-flow growth decays much faster than EPS growth, you will meet a major culprit starring prominently in later chapters—information manipulation. The closely watched EPS figure is manipulated more intensely than are the less scrutinized cash flows, thereby giving the appearance of a longer-lasting EPS growth. By now, the picture should be clear: your likelihood of sooner rather than later disappointing investors with an EPS or cash flow decline or, heaven forbid, a miss of the consensus analyst forecast of СКАЧАТЬ