Winning Investors Over. Baruch Lev
(e.g., increase institutional investors' share). The SEC's Regulation Fair Disclosure (2001), which prohibited restricted communication with investors, increased the demand for IR professionals to navigate public communication to capital markets. Raising the awareness of buy-side analysts and investors, said the interviewees, is the most important part of the IR function, generally aimed at creating a stable and sophisticated investor base and boosting trading activity (stock liquidity). Catering to sell-side analysts and the media follows the buy-side as IR objectives. Enhancing the credibility of managers as straight shooters is also a major target of IR, coming in handy when scandals, like earnings restatements, erupt or a proxy contest with activist investors looms. Clearly, IR professionals aspire to do more than just book good hotels for managers. But are these elevated objectives achieved with IR help?
The empirical part of the Bushee-Miller study takes up this issue. It examined a sample of 210 midsize and small companies—those with the largest potential benefit from IR in terms of visibility—that hired IR consultancies. The researchers compared the companies that hired IR consultants with a control group of companies of the same exchange listing, industry, and institutional ownership, which didn't hire IR professionals. The researchers first examined the determinants of the decision to initiate an IR activity and found once more that perceived share undervaluation and low company visibility were the major reasons for hiring IR consultants. As for the consequences of this decision, the findings will surely please IR professionals:
We find that media coverage increases almost immediately [after the IR initiation]. The increase is maintained over the next year, but does not grow over time. Analyst coverage also increases; however, it takes several quarters to develop and is not always sustained … Firms initiating IR activities experience a significant and persistent increase in both the number of institutions and the percentages of institutional ownership that is greater than for the control firms … Moreover, we document that firms initiating IR programs experience significant improvements in their market valuation … Overall, these results suggest that IR activities play a significant role in helping small and mid-cap companies to overcome their low visibility.41
But wait, before you rush to hire an IR consultant, consider first that IR is not a one-shot affair. For the positive outcomes noted by Bushee and Miller to persist, you have to maintain a sustained and costly IR effort. Since Bushee and Miller didn't match the cost of IR against the benefits, the issue of IR's cost-effectiveness is still an open one. Second, as always, statistical results are “on average”; there is no assurance that in your particular case all the documented IR benefits will materialize. Nevertheless, this preliminary research does suggest a considerable potential for IR activities to create value, particularly for small, “neglected” firms starting from a low visibility level.
And what about larger companies with ongoing IR activities? Agarawal et al. examined companies with high IR quality ratings from 2000 to 2008 in the “Best Overall IR” survey of Investor Relations Magazine, a trade journal.42 Their main finding is that companies in the “Best IR” list have a higher market value (capitalization) than similar companies not rated by the magazine, and the “best” companies also enjoyed a positive abnormal stock return (adjusted for risk, size, etc.) during the year following their appearance on the “Best IR” list. As frosting on the cake, nominated companies also saw an increase in the number of analysts following them. This is a strong endorsement of the effectiveness of IR activities, although (sorry for the downer) the documented relation between good IR and high market value could also reflect a certain reverse causal effect—from successful companies to better IR. It stands to reason that profitable companies with higher market values can better afford advanced IR activities. While it is notoriously difficult to determine causation (as opposed to correlation) with statistical tools, the relation between good IR and the subsequent increase in the number of analysts and share performance does suggest a causation, from IR to positive outcomes.
A Final Note on Visibility, Disclosure, and Stock Prices
Empirical findings, I learned long ago, have to make sense in addition to being statistically significant. How can the hiring of an IR consultancy increase share prices, as Bushee and Miller document? What's the process that leads from enhanced visibility and improved transparency, both important IR objectives, to higher market capitalization? Financial hocus-pocus? Not really. Here, briefly, is the important chain of events, where each link is supported by empirical research.43
An effective IR program reduces analysts' and institutional investors' costs of obtaining and processing information about companies and their growth prospects. This is done by improving the quality of information, such as systematically disclosing beyond-GAAP data, like drug companies' product pipeline or data on the effectiveness of restructuring efforts (see chapter 7). Also, improving information quality involves securing wide analyst participation and the quality of presentation in quarterly and annual conference calls, arranging media coverage for important company events, and making executives available for background discussions with analysts and major investors. The objective here is to reduce information costs for analysts and investors who are seeking information yet have limited attention.
Next, evidence indicates that improving information quality and investors' accessibility to information sources increases the number of analysts following the company and enhances institutional demand for its shares. This, in turn, increases the liquidity of the company's shares—the ability to buy or sell stock without a considerable price impact—a highly coveted share attribute by institutional investors, reflected by a high volume of share trade.44 The key here is that more analysts, buy- and sell-side, and improved analysts' product—earnings forecasts and stock valuations—enhance the stock's liquidity.
And, finally, since investors, institutions in particular, highly value liquidity, they are willing to pay a premium for it, requiring a lower rate of return on the stock. This ends the virtuous cycle, from effective investor relations to a higher shareholder value.
In sum, the various communication channels (conference calls, earnings releases) and information facilitators (investor relations, business media) I have analyzed in this chapter work their magic, when effective, through the following chain:
Reduction of information costs → increasing the number of analysts following and institutional investors' visibility → enhancing share liquidity → stock price and volume improvements
A company can achieve all this without a formal IR function, but trained and capable IR professionals undoubtedly facilitate the process from information to higher value, and conserve precious CEO and CFO time.
Operating Instructions
I opened this chapter with a dysfunctional conference call, long on rosy assertions, short on details, and mum on forward-looking guidance. In contrast, TCF Financial, a bank, held a conference call on January 15, 2004, that also followed a disappointing quarter and year—decreasing earnings and missing the consensus estimate—yet its stock price increased during the call by about 2 percent. What gives?
TCF's call opened with the CEO's brief, matter-of-fact presentation providing a clear outline of the causes of the earnings shortfall (primarily low interest rates, causing enhanced loan prepayments) and proceeding with specific curative plans for next year (such as opening twenty-four branches). No fluff, no empty reassurances. Giving truth to sharing the pain, TCF's CEO announced during the call that since the 2003 earnings goal was missed, “TCF management will not be receiving incentive compensation this year.” How refreshing. Furthermore, the CEO set a tough earnings goal for incentive compensation for 2004: $3.70 EPS versus the disappointing $3.05 EPS in 2003. The answers to analysts' questions during the call were equally informative, quantitative, and, more important, forward looking. To a question about debit card revenue next year, the answer was, “net debit card revenues will increase next year by approximately 10 percent”—a verifiable target, enhancing managers' credibility. Regarding the outlook of the bank's leasing equipment business, the important forward-looking indicator of a leasing backlog of $187 million at the end of 2003 was given. A question about the 2004 tax