In response to ongoing corporate communications disasters, global regulators continue to introduce new legislation mandating the type of information that must be communicated to investors, and how it must be communicated. The new rules range from major enactments such as the European Union’s (EU) transparency directive on modifications to the timings of SEC filings by US-listed companies.
These regulatory initiatives fall short in two ways, however. First, they do nothing to explain the complex financial structures many companies are adopting as they seek to fund future growth. As organizations grow, innovative financing techniques make it more difficult for outside investors to understand a firm’s risk profile and the performance of its various lines of business.
Traditional accounting standards have not kept pace with the risk-management tools employed by sophisticated corporations. Thus, more meaningful disclosure of firms’ risk-management positions and strategies is crucial to improve corporate transparency for market participants.
For example, securitization of assets helps manage the risk of a concentrated exposure by transferring some of the exposure outside the company. By pooling assets and issuing marketable securities, firms gain liquidity and reduce funding costs. Of course, moving assets off the balance sheet and into special purpose entities generates its own risks and reduces transparency, unless the firm takes steps to enhance disclosure. So IROs must also do their part, ensuring public disclosures clearly identify all major risk exposures and their effects on the firm’s financial condition, performance, cash flow and earnings potential.
The second issue is how corporate governance and its related transparency is shaped by the increasing importance of institutional investors, such as mutual funds and pension funds. According to the flow of funds accounts published by the Federal Reserve, the combined share of US corporate equity managed by mutual funds, pension funds and life insurance companies grew from only 3 percent in 1952 to 48 percent by the third quarter of 2003.
Companies are now acutely aware of shareholder power and the role activist institutional investors play as ‘monitors’ of their corporate governance performance. From a market perspective, this activism might provide market discipline directly by preventing management from pursuing its own interests at the expense of shareholders.
As a result, companies say they are making greater efforts to communicate, but also that these efforts are not being reciprocated by investors. Executives are irked when they can’t identify to whom communication should be directed; there are many possibilities: chairman of the investment fund, chief investment officer, various fund managers, corporate governance analysts and compliance officers, to name but a few. Exactly who within the institution is responsible for buy and sell decisions is not always easy for an IRO to establish.
Broadening communications is therefore critical; simply posting information on your web site is not sufficient. Online communications should be complemented with dissemination to the media and information systems used by institutional investors. Properly distributed press releases are the most effective way to ensure all of these investors receive the news in a timely and secure manner.
Of course, communication comes at a cost. But there is a growing body of opinion and evidence to suggest that a successful transparency campaign brings financial benefits. Among their findings, the OECD roundtables held earlier this year concluded: ‘Transparency and disclosure are not only topics for accountants and auditors; opacity comes at a real economic cost. It can have an adverse effect on capital allocation, which in turn lowers productivity and per-capita income. It will raise the cost of capital, both because it specifically facilitates tunneling, and by the more general impact it has on investor confidence. A higher cost of capital can in turn lead to lower investment and output. Lower investor confidence resulting from opacity will lead to less financial market activity – less turnover and liquidity.’
The latest results from Global Metrics International – although based on a small sample – also show companies with a high corporate governance rating outperformed the S&P 500 in total shareholder returns for three successive years.
Companies and their IROs are being asked to do a lot with new governance and regulatory requirements. But those who make extra effort to achieve real transparency will certainly see greater returns. The benefits of these efforts will eventually outweigh the costs.
