(Author's Note: A version of this post originally appeared on the web site Corporate Eye. I liked it so much that I am recycling it here.)
People
in the academic world are big on constructing models to prove their financial
theories. These hypothetical constructs blithely disregard such things as
taxes, transaction costs and the fact that emotional, sometimes illogical
humans are part of the market process. They don’t allow messy reality to
interfere with their elegant equations, but the models are useful in
highlighting a theory or hypothesis. Many an academic prize (and even some
Nobel Prizes) has been won by building explanatory models that make huge
assumptions and leaps of faith. In fact, my favorite quote about finance makes
a nod to this as it relates to the Efficient Market Hypothesis. Fischer Black,
a former Professor at the Massachusetts Institute of Technology (MIT), which
sits next to the Charles River in Cambridge, Massachusetts, took a job with
Goldman Sachs in New York, situated next to the Hudson River. After working
there for a while, he was heard to remark, “Markets look a lot less efficient
from the banks of the Hudson than from the banks of the Charles”.[1]
As
I consider myself only a quasi-academic – that is, I teach but I don’t engage
in any of the pedantic research that clogs the academic financial journals
(plus, I have not yet sewn patches on the elbows of my tweed jacket, nor have I
taken up smoking a pipe), I thought I would serve up for the benefit of my
readers a theoretical quasi-model to help think about the value of investor
relations. Recognizing that investor relations is a discipline that involves
real people and information, I will keep it quasi-simple.
Start
by thinking of two theoretical firms, both in the same industry and each
performing exactly the same in financial terms. That is to say, according to
their past performances, their growth rates are similar, their rates of return
do not differ in any material way and they serve the same customer base. Firm A
discloses exactly what is required by the regulations, and nothing more. It makes
no effort to explain its more complicated accounting treatments and it does not
reveal anything about its strategy or future plans. It does not respond to
investor inquiries, does not make management available to investors and
analysts, and does not present at any industry conferences. In short, beyond
the regulatory filings it makes, it remains silent.
Firm
B on the other hand, tries to be as open and transparent as possible, going
beyond the regulatory disclosure requirements to explain its business and
strategy, meeting with investors and regularly presenting at industry
conferences. They keep up a steady stream of information that keeps investors
informed on a timely basis, not just on a regulatory filing basis.
The
question to be asked then, is under that hypothetical situation, should Firm B
get a higher valuation than Firm A? I submit that under these conditions, it is
highly likely that a premium will be attached to the valuation of Firm B,
compared to Firm A. There are several reasons for this, chief of which is that
investors will view the greater transparency into operations and management
thinking about the future as enabling them to make better estimates about
future cash flows. Secondly, the cost to investors of acquiring information has
been lowered by Firm B, and this should show up in their valuation. Third, the
amount of information asymmetry between the company and the investors has been
lowered by Firm B, which should also be reflected in a higher valuation.
Finally, although the information Firm B extends beyond that required by the
regulations is not material in any one piece, in the aggregate it may help in
the assembly of a mosaic of information that may be material to investors.
Unfortunately,
I do not have an elegant equation to quantify the value of the of these
investor relations activities. I do think it suggests however, that at least
for companies where information is widely disseminated, much of the value in
investor relations is in the selection and disclosure of information beyond
what is required by regulation.
Now,
if you want to nominate me for an academic prize, be my guest. Of course, with
my luck it will turn out to be a quasi-prize…
Posts
1 comment:
my IR experience (and I've been out of IR for 5 years) is that investors wake up in the morning to create and fine tune their models. Half of all questions on conference calls were attempts to fill in model blanks. So companies that provide info that make it easier for analysts to do their jobs may benefit from increased coverage, increased liquidity, and the valuation premium that often accompanies.
Post a Comment