INVESTORS "claim that they learn something more subtle than actual facts from the CEO’s tone or demeanour", says Dr Simon Taylor of Judge Business School in the Financial Times. But it’s unlikely. "Perhaps those with advanced psychological training or a background in the CIA or MI5 might be good at this, but the average investor or analyst, armed only with Body Language for Dummies and the usual human biases, is likely to learn nothing. CEOs, often chosen more for their presentation skills than ability to run a business, are well rehearsed and quite adept at fooling investors."
Taylor’s point is that meeting the CEO rarely yields anything useful for investors.
Baruch Lev, professor at New York University’s Stern School of Business, disagrees. "Executives’ narrative and tone colour many investors’ decisions and account for most stock price changes in the wake of financial reports. Giving more information to investors generally, in an honest and understandable way, is good business," he says. "That’s not a loose assertion. It has its roots in the theory of information asymmetry. When one party to a transaction knows more than the other, someone suffers — and it’s not who you might think. When sellers have information about the quality of a product that buyers don’t, sellers are actually losers, as suspicious buyers drive down prices or abandon the market. (www.jstor.org/pss/1879431.) Managers who don’t share information face a substantial share price discount, a higher cost of capital, and a more volatile stock price."
Taylor’s contention, therefore, would come at a price.
"Interacting with investors is not only about giving information," says Lev. "Information flows both ways: executives can learn from investors. Stock price movements around earnings announcements reveal a lot about investors’ growth expectations and their perceptions of management’s credibility.
"Short sellers often signal serious operating and accounting problems. Wide bid-ask spreads and a large variability in analysts’ forecasts point to investor uncertainty about the future of the business."
The idea that company managers and investors can have a mutually beneficial relationship has, unfortunately, taken a beating. In response, some at business schools have advised managers to pay less attention to shareholders — who are just one class of stakeholders, and may not be the most important. Most investors focus on the short term. Catering to their whims interferes with long-term growth and wastes valuable management time, goes the claim. Managers should run the business, and investors will fall in line.
"But disengagement from the market isn’t an option," says Lev. "The heads of publicly traded companies can’t run their businesses without reference to the capital market. The market determines a company’s cost of capital and therefore affects its future growth. Capital markets play monitoring roles in managers’ compensation and careers. Share price patterns serve as beacons, guiding qualified employees to join, stay with, or leave an organisation (no one enjoys holding underwater stock options).
"The key for executives is not to ignore Wall Street but to be smarter in their dealings with it — to start with a clear sense of the strengths and weaknesses of investors. In a caricature found in the corporate world, those who buy and sell stocks are skittish, myopic ninnies. Whereas, in the view that has long held sway in academia, they are cold-blooded, all-knowing information processors," says Lev.
"In recent years, researchers have come to a more nuanced view: on the whole, investors are neither incompetents nor automatons."
To dispense with the "myopic ninnies" claim: several studies find that investors are more interested in companies’ medium-to long-term prospects than in what is happening today. Tom Copeland, Aaron Dolgoff and Alberto Moel write in Accounting Review that long-term forecast revisions affect share prices powerfully.
But investors aren’t all-knowing either. A study by Gur Huberman and Tomer Regev of Columbia University of the effect of "news" that had already appeared elsewhere, confirmed that "enthusiastic public attention induces a permanent rise in share prices, even though no genuinely new information may be presented".
Other research shows investors suffer from "limited attention", a restricted ability to process vast amounts of information relevant to company valuations.
The upshot is that investors are somewhere between naive and all-knowing. They care about what drives a company’s long-term growth, but need help understanding what those drivers are. "That’s where the tone of managers’ communications come in," says Lev.
© BDlive 2013