Means Opportunities and Challenges for Companies and IROs
Louis M. Thompson, Jr.
2005 - In the eyes of Congress and the SEC, the new rules
resulting from the Sarbanes-Oxley Act (SOA) were designed
to restore investor confidence. Several regulations were
designed to increase transparency of corporate information
by providing a more accurate picture of a company’s
value and to restore confidence in the accuracy of financial
information reported to the SEC.
from an investor’s perspective, more information is
not necessarily better information. “Transparent”
means the information must be clear and understandable.
But corporate investor relations officers (IRO) often struggle
with legal counsel and accountants about how to present
information that is truly transparent.
companies seem to have fallen into a “compliance by
checklist” mode with respect to disclosure and corporate
governance. While this mentality may provide assurance that
a company is following the rules, it is debatable whether
investors are better off for it.
to a National Investor Relations Institute (NIRI) survey,
the reconciliation requirements of SEC Regulation G, Conditions
for Use of Non-GAAP Financial Measures, have caused a 10%
decline—from 69% to 59%—in the number of companies
reporting non-GAAP information since the rule took effect.
While this rule was necessary to correct some of the abuses
of pro forma reporting, some companies go overboard in assuring
compliance. A Fortune 500 company IRO said his company had
25 people involved in preparing the Management’s Discussion
and Analysis (MD&A) part of a company’s financial
statements, and that, while he believed the end result was
fully compliant, he acknowledged that it was far from transparent.
the SEC’s December 2003 guidance on MD&A, it called
on companies to communicate information as seen “through
the eyes of management” and in plain English. The
release encourages companies to create an MD&A executive
summary that allows one to get the essence of management’s
analysis of the results and key trends going forward; an
investor can then get more detailed information in the body
of the document.
lawyers advise against an executive summary, saying it might
subject a company to a shareholder lawsuit for errors of
omission should the executive summary be found to have omitted
a material item. An SEC official I spoke with said this
is an overreaction, and recommends that the company’s
IRO either write the MD&A or be intimately involved
in the process, to ensure that the information is consistent
with what the company is telling the investor community.
SEC also urges management to discuss key nonfinancial value
drivers, which often constitutes a major component of a
company’s market value. This presents companies a
significant opportunity to move the market from a short-term
focus on earnings to a more complete valuation model.
the early 1990s, many observers have recognized that a company’s
nonfinancial factors or intangible assets play a key role
in how the market values its prospects for performance.
New York University Stern School of Business professor Baruch
Lev determined from 1989 NIRI-sponsored research that about
40% of the average S&P 500 company’s market value
could not be explained through the financial statements.
This led him to search for the factors that drive this valuation
thereafter, the AICPA formed a committee under Ed Jenkins,
who later became FASB chairman, to explore how nonfinancial
factors might be disclosed through corporate reporting.
In the mid-1990s, Carolyn Brancato, director of the Conference
Board’s Global Corporate Governance Research Centre,
created a special Conference Board committee to further
explore disclosure of nonfinancial performance measures.
Concurrently, Sarah Mavrinac, a researcher specializing
in strategic performance measurement, reported a groundbreaking
study for Ernst & Young, “Measures That Matter,”
on the importance that mutual fund managers placed on nonfinancial
factors in making investment decisions.
recently, books on how intangibles drive corporate valuation
have been published by such authors as Baruch Lev; Jonathan
Low, a research fellow at the Cap Gemini Ernst & Young
Center for Business Innovation; Pam Cohen Kalafut, a sociologist
now with consulting firm Predictiv; former Harvard professor
Robert Eccles; and former Pricewaterhouse-Coopers partner
and current FASB chairman Robert Herz.
new development is the creation of the Enhanced Business
Reporting Consortium, funded in part by the AICPA, a private-sector
initiative with the goal of developing a business reporting
model incorporating nonfinancial factors. NIRI is a charter
strategic partner in this effort; its interest is in developing
models, probably along industry lines, for communicating
information about nonfinancial factors to the investment
desire on the part of companies to shift the market’s
focus to more long-term valuation is still complicated by
analysts’ pressure on companies to provide quarterly
earnings guidance. According to a March 2005 NIRI survey,
71% of companies provide earnings guidance, and an increasing
number, 61%, of those issuing earnings guidance provide
annualized guidance, quarterly guidance, or both; 93% update
their guidance if it changes materially.
those providing earnings guidance, 80% provide a range of
estimates, only 5% provide a point estimate, and 10% publicly
issue their internal earnings forecasting model. Most of
the 29% that provide no earnings guidance per se still provide
guidance on trends that may impact the company’s business,
qualitative statements about performance measures that drive
value in the company, and qualitative statements about market
companies report earnings, NIRI’s Standards of Practice
for Investor Relations urges them to include in their earnings
release a balance sheet and a statement of cash flows, in
addition to the traditional income statement. NIRI recently
found that 46% of companies include a balance sheet and
cash flow statement, 41% provide only a balance sheet, and
and Corporate Governance
it comes to addressing growing shareholder concerns (e.g.,
the call for increased participation in the proxy process
and the nomination of directors), IROs should be active
participants in corporate governance. An IRO should be the
intelligence link between the investment community and the
corporation, bringing the concerns and issues they hear
from Wall Street to the board of directors and senior management.
IROs should also help educate the board on the shareholder
mix, what drives value in the company, and investor trends
affecting the company’s peer group. IROs can also
be the “corporate conscience,” advising the
board and management on what is in the best interests of
the company’s investors.
an IRO should construct the rationale for supporting the
company in proxy issues and should actively communicate
this to institutional and individual investors. If a company
has difficulty coming up with a good rationale, perhaps
it is on the wrong side of the issue. Companies should remember
that in many of the recent contested proxy issues that received
a majority shareholder vote, the swing votes came from the
New Model Needed for Research
companies have found it a challenge to receive sell-side
research coverage since the dramatic changes that have taken
place in the wake of the $1.4 billion global settlement
involving the top 10 brokerage firms and the implementation
of SOA section 501 on analyst conflicts of interest. With
the wall between investment banking and research being enforced
both within brokerage firms and by the SEC, sell-side firms
have found it a challenge to find a business model that
makes research pay for itself.
firms decrease their research coverage, many analysts are
moving to hedge funds and mutual funds. Some have joined
or started independent research firms that “sell”
their research to the buy-side through hard- and soft-dollar
arrangements. Some are writing “issuer-paid”
research on behalf of companies that have lost traditional
sell-side coverage. To that point, NIRI and the Chartered
Financial Analyst Institute have issued guidelines for issuer-paid
research. Recently, Nasdaq and Reuters announced a joint
venture to provide issuer-paid research, particularly for
companies that have no sell-side coverage. A new organization
called the National Research Exchange is offering similar
research opportunities for companies.
decline of sell-side research is causing companies to redouble
their efforts to meet directly with the buy side. This means
more one-on-one meetings and presentations before investor
conferences. It is also causing companies to increase their
vigilance on Regulation FD compliance.
public companies deal with the investment community has
changed dramatically over the past two years, and more changes
are coming. The IRO role is changing: operating at a more
strategic level in terms of communicating information related
to both financial and nonfinancial performance and prospects;
getting the message to the institutional and individual
investors; being an active participant in the corporate
governance process; being intimately involved in developing
disclosure documents such as MD&A; and complying with
real-time disclosures under the new Form 8-K filing requirements.
M. Thompson, Jr., is president and CEO of NIRI. He
has served in an advisory capacity for the SEC chairman, is
serving his second term on the New York Stock Exchange Individual
Investor Advisory Committee, and is on the board of the National
Council for Economic Education.