At Niri’s annual meeting last March, former chairman Len Griehs, vice president of investor relations at Campbell Soup, stated that Niri’s performance was so good in 1997 that ‘if we had a stock price, it surely would have beaten the market.’ To this add, ‘…particularly if the performance was unexpected.’ After all, in an efficient market, it is changes in investor expectations that drive stock prices.
Considering the elevated standing of the investor relations function in the US, was it previously undervalued? Or have the expectations for IR been revised upward? In other words, is the investor relations market efficient? The answer is not trivial: if the function merely had a marketing problem, then past practices should sustain it into the future.
However, since the early 1990s, expectations for the investor relations business have steadily been revised upward in anticipation of the IR manager fulfilling a role of increasing strategic importance – the role of chief equity intelligence officer (CEIO). And only by living up to these elevated expectations can the function hope to sustain its value in the eyes of corporate executives.
In 1992, the SEC began requiring public companies to include a stock price performance graph in annual proxy statements opposite executive compensation information. The clear intent of the regulation is that executive pay should be related to the creation of value. The SEC goes one step further by requiring companies to show their performance relative to a market benchmark. Absolute value creation isn’t sufficient – only superior returns relative to the market should be rewarded. This was a seminal event, one that transformed shareholder value from a theoretical, academic subject to one of high strategic – and personal – importance. In the process, the SEC created a practical need to integrate market intelligence and strategic planning, and the chief equity intelligence officer was born.
Building shareholder value
Historically, the challenge facing corporate management has been year-to-year improvement in operating results, and even today it’s fairly common for a press release to state a company has ‘achieved record results for the third consecutive year’ or ‘increased dividends for the 40th straight quarter.’ Companies are comfortable with their own operations and their own data, of which there is never a shortage.
The management challenge today – achieving superior shareholder returns relative to the market – requires an ‘external perspective’. To understand total return, a company must understand the assumptions that their investors are making in valuing the stock, as well as the market’s expected return. The firm must look outside of itself to address these issues.
Abbott Labs provides a classic example of the role expectations play in stock performance. Anyone looking at Abbott’s financial performance would conclude that it’s extremely well managed: by most definitions, the company has been wildly successful for many years. However, for the past five years, Abbott’s stock has merely been a market performer. Why? Because Abbott’s performance is routinely anticipated years before it occurs: in early January 1995, the consensus analyst estimate for 1997 was $2.65. Ultimately Abbott reported 1997 EPS of $2.72 – ‘record earnings’ – and the market yawned. A similar pattern has occurred for Abbott for years. The market is a relentless adversary.
We all know this is how the market works, but we don’t pay enough attention to the implications. Because superior shareholder returns normally develop when a company’s operating performance exceeds investor expectations, just seeing the historical patterns in a company’s performance – even correlating these patterns with historical changes in stock price – isn’t enough. For a company to generate superior returns, it has to improve performance unexpectedly, or maintain superior performance for an unexpectedly long time. Only by understanding external market expectations can management design a plan to build value for shareholders. The importance of cultivating an external perspective is echoed by leading business strategists: according to Peter Drucker, ‘What a business needs most for its decisions – especially strategic ones – are data about what goes on outside of it. It is only outside the business where there are results, opportunities and threats.’
Emergence of the CEIO
Fortunately, an abundance of complex intelligence – investor expectations, competitive performance differentials, changes in relative prices and likely future trends in a wide variety of businesses – are all available from the world of investors and markets. Stock prices are a simple but powerful example. Stock price is an unbiased measure of value, and also one of the best measures of the job management is doing in dealing with all its constituencies: owners, employees, customers and suppliers. It’s quite unusual to find a company that has afforded superior returns to shareholders over sustained periods but that has bad management, low morale, poor labor relations, unhappy customers or suppliers, or legal problems. Hence, stock prices are a great source of real-time feedback on how a firm and its industry are doing.
Companies committed to achieving superior returns to shareholders understand the importance of incorporating market intelligence – such as stock prices – into their decision processes. The CEIO fulfills this role by monitoring changes in the outlook for the company, its industry and the larger equity market, and using this intelligence to guide the firm’s investment, operating and financial decisions. In addition, the CEIO typically fulfills a complementary role – the traditional investor relations role – of communicating to investors the goals and strategies of the firm. The emergence of the CEIO and resulting elevated stature of the profession reflect a common principle: communication at its best is a two-way street.
Listening to shareholders
A critical factor in developing the external perspective that enables companies to generate superior returns is understanding shareholders. No-one cares more about shareholder value than a firm’s owners. Listening to them – understanding their expectations and interpretations of the business environment, corporate strategies and financial policies – can reveal a lot. The growing stature of the buy-side, though it poses many challenges, presents important opportunities.
The emergence of the CEIO is a response not only to the 1992 SEC regulation, but also to fundamental changes in the investment management industry. Historically, communication between the firm and investors was essentially one-way and uniform. Companies and investment managers relied on the sell-side community to broker information from the companies to the buy-side.
However, over the last 20 years the active segment of the investment management industry has experienced explosive growth – both in terms of assets under management and the number of mutual fund products. Technological advances, increased disclosure and the remarkable increase in information channels have reduced both companies’ and investors’ reliance on the sell-side. The result is that the sell-side is no longer the exclusive or even the dominant intermediary between the company and the market. Asset managers are doing more research in-house and portfolio managers are demanding more direct communication with key corporate executives.
In the midst of this transformation, the number of investment opportunities is increasing. Competition for capital has intensified even as the pool of available capital has expanded. No wonder the role of the CEIO is gaining credibility. The CEIO’s knowledge of the market and investors fosters an integrated view of the many components which shape investors’ expectations – and drive share value. The CEIO plays an integral role in shaping and communicating a company’s ‘value creation proposition’ – the case for why portfolio managers will make more money in their stock than in an index fund or industry sector fund. By understanding the opinions and concerns of portfolio managers and tracking expectations for peers and the broad market, CEIOs help corporate planners identify emerging trends. They work with other members of senior management and the board to evaluate the total return implications of strategic initiatives and financial policies. They help identify areas of weakness and opportunities for improvement – relative to market leaders rather than their own existing structures.
Increasingly, achievement of superior shareholder returns over reasonable time periods is the yardstick to which management is held accountable. Achieving superior shareholder returns is a process that requires a strategic commitment – and the right tools. It is one thing to be the master of one’s domain, it is entirely another to get one’s arms around the market. As companies increasingly rely on an external perspective to make value enhancing strategic and financial decisions, the role of the chief equity intelligence officer will assume its justifiable place at the boardroom table.
John Lafferty is president of JM Lafferty Associates Inc in Chicago.
