August 22, 2013

These books will take you from theory to practice

By Brad Allen – Originally published on

Two titles explain best practices with hard evidence, says Brad Allen

Much of what has been written on the topic of communicating with investors is filled with advice built on anecdote and experience.

But we live in a data-driven world and savvy IROs know if they are going to get that seat at the table they need data to back up their recommendations – and two recent books on the topic of communicating with investors stand out for their emphasis on research and data, rather than just opinion.

Winning investors over by Baruch Lev, accounting and finance professor at New York University’s Stern School of Business, is a data-rich immersion into the investor communication soup.

He looks not just at his own research on investor communication and outcome over a career of more than 40 years but also through the broader lens of all the academic literature on the topic.

Comprehensive and wide ranging, the book delves into everything from communicating in a crisis (clarity, succinctness, transparency and focus on remedies win over obfuscation and excuse) to a rebuttal of Wall Street short-termism (more than half of a company’s market cap reflects its long-term growth potential rather than near-term profits).

Lev also dissects, in compelling detail, the weak link between performance and executive pay and provides a blueprint for fixing it.

Some of Lev’s more provocative writing centers on quarterly guidance. One study of 180,000 quarterly earnings events finds a statistically improbable distribution of outcomes, with 13 percent hitting the mean Street estimate exactly, while 26 percent beat it by $0.01 to $0.03 and only 15 percent miss by a similar margin.

This kabuki dance around earnings, Lev argues, explains the outsized negative reaction when a firm misses earnings by just a penny. With such an improbable skew to meeting or beating estimates, he says even a small miss ‘suggests to investors the existence of serious business issues lurking in the background.’

But Lev does not join the call for doing away with guidance. Instead, he uses the data to show that providing management’s forward view on a consistent basis benefits both investors and the company because it ‘enriches the overall information environment’ increasing transparency while reducing volatility and the cost of capital.

In one of his more important chapters, Life beyond GAAP, he argues for more voluntary disclosure of factors important to the company, such as patents for a tech company, or cost of client acquisition for an online media company. But he says these measures should be standardized and reported consistently over time.

Investing between the lines by LJ Rittenhouse, a former senior vice president of Lehman Brothers, has a lot to say about communication in general and CEO communication in particular.

Rittenhouse founded her IR consultancy in 1991 and, over the years, she developed various measures to rank company communication across several familiar dimensions such as capital stewardship, business sustainability, strategy, leadership, vision and stakeholder relations. She draws a critical distinction between transparency and candor, describing the latter as ‘not just accurate, but also authentic’ communication.

Rittenhouse has evaluated thousands of CEO letters to shareholders, measuring them for candor and its opposite, which she calls FOG – fact-deficient, obfuscating generalities – characterized by a lack of relevant context and a surfeit of jargon and clichés. Her findings? Ranking 100 companies from the Fortune 500 by their candor/FOG scores is highly predictive of market performance.

The top-ranked companies for candor outperformed both the bottom quartile and the S&P 500 across all but three 12-month and 24-month periods from 2005 through 2011. Over the entire seven-year span, the candor kings post an average 59.8 percent return compared with 15.3 percent for the FOG-shrouded companies, and 36.4 percent for the S&P 500 as a whole.

Neither book should sit quietly on any IRO’s shelf. They should be dog-eared, filled with flags, passages underlined and highlighted, bringing data into the discussion on best-in-class investor communication. Going from theory to practice is what IROs get paid for. Next month I’ll look at some IROs who have ridden in that bumpy chair and lived to tell the tale.