Wednesday, March 28, 2012

Moneyball for Investor Relations

I recently read Michael Lewis’ book Moneyball and was struck by some of the similarities between what it discusses and what commonly occurs in corporate investor relations. For those of you who may not have read the book or seen the movie, Moneyball is the story of Billy Beane, the general manager of the Oakland A’s baseball team who successfully positions his team to compete against teams with much larger payrolls than the Oakland A’s were able to afford. He does this by going against conventional wisdom and finding players that do not fit the establishment’s idea of what a professional ballplayer looks like but who contribute to winning in ways the establishment doesn’t value. In essence, the normal way of viewing these players allows their salaries to be mispriced in the marketplace and a general manager that appreciates this can assemble a winning team for considerably less money. (The football equivalent of this phenomena is Tim Tebow, who does not fit pro football’s concept of what a professional quarterback looks like or does. All he does is win yet the Denver Broncos seemingly couldn’t get rid of him fast enough.)
In investor relations, corporations are constantly applying conventional wisdom to their detriment, which in their case means that the value of their stock suffers. Take, for example, the following statement: “This is what the regulations require us to disclose, and therefore that’s all we are going to say”. This is what I call the regulatory mindset trap. The regulations describe the minimum disclosure requirements, but they don’t tell you to put it in context, or to make it intelligible. Anyone who has ever tried to parse through statements in annual reports dealing with deferred tax accounting or pension accounting can tell you that it is very difficult to make heads or tails of these sections without help from the company. In academic terms, when companies do this, they raise the cost of acquiring the information. This is because investors have to devote more resources towards understanding the information. Further, it also raises the specter of asymmetric information, that is, the information gap between what management knows and what it allows investors to know. Studies have shown that both increasing the cost of acquiring information and high information asymmetry will increase the cost of capital by lowering liquidity in the company’s shares.
Or consider the conventional wisdom that causes companies that take the position, “We simply report what we have done, and we leave it to the investors to figure out what our performance will look like in the future.” When you consider that the value of your company’s stock is equal to the sum of its future cash flows, discounted back to a present value (this is Finance 101), not discussing the future is obviously leaving off a critical piece of information. Investors will then make their own forecasts, whether a company helps them or not.  The forecasts then become harder to make and carry a greater degree of uncertainty without some input from the company. As a result, future values will be discounted to a greater degree, leading to lower stock prices.
So the investor relations thought for the week is that if you hear someone at your company say, “We can’t say that” or “We’ve never disclosed that”, question the conventional wisdom. Your stock could be mispriced simply because investors don’t have the right information needed to make an informed decision about the stock.


Jeffluth said...

There are many prevailing wisdoms in Investor Relations. One of them is that "investors have choices." So unless there is a compelling reason (one that transcends the quality of disclosure) to own shares of a given company, then investors will gravitate towards companies that are easier to understand and model.

Tech Titan said...

What do you think will happen to that mindset when more regulations are required i.e. Dodd Frank and with the advent of social media? Corporations are always scared of illegally leaking information and social media would compound that problem by a factor of 100.

Do you think that people will become even more "trapped" in this mindset? Anything you say or do can be transmitted around the world instantly so I think people are much more cautious about that.