Proxy Access - Who Benefits?

There is a famous Latin saying, “Cui bono?” that was used in Roman trials to help determine the underlying truth of a matter. The phrase translates into “To whose benefit?” and is meant to suggest the possibility of a hidden motive or that the party responsible may not be who it appears to be at first. And so it is with proxy access, recently adopted by the Securities and Exchange Commission.

The thinking behind proxy access appears pure at first – to promote shareholder democracy by letting shareholders utilize the corporate proxy statement rather than go through the expense of mounting a proxy campaign of their own. But over the years, I’ve come to be suspicious of anything that drapes itself in motherhood and apple pie, whether it comes from the right or left side of the political spectrum, and so I started to think about who really benefits from proxy access.

As I understand the new rule, shareholders who have held at least 3% of a company’s stock for at least 3 years will be able to nominate up to 25% of a company’s board of directors using the company’s own proxy statement. So I guess this is a move to open up corporate boards to shareholders, but I wonder, which shareholders?

Retail? Certainly not retail shareholders; for the most part they don’t reach the 3% threshold.

Hedge Funds? Unlikely, as the turnover in their portfolios means that it is doubtful they will hold stock for 3 years.

What about activist investors – might this new rule inure to their benefit? Possibly, but not to a large extent. A paper entitled “Hedge Fund Activism, Corporate Governance and Firm Performance” suggests that the median holding period for activist hedge funds is 556 days, or 18.5 months. While this might be longer than you thought, it is still only half the time required by the new rule.

Mutual Funds? I suppose mutual funds might be a beneficiary of the new rule, but I’ve never known them to take an interest in nominating directors.

So who’s left? What entities have the financial muscle to hold 3% of a company’s stock for 3 years? What entities have exhibited a desire to use the proxy system to agitate for their own agendas? The answer is: Foundations and Pension Plans. Of these the bulk of the money is represented by pension plans. Add to that the fact that, according to The Wall Street Journal, four out of five for profit corporations have moved away from pension plans, while unionized employees both in the private sector and government, have fought to retain their fixed benefit pensions and the picture of who benefits starts to become clearer.

Least you were in doubt on the issue, consider also that the SEC adopted the rule in a party line vote, 3 democrats for and 2 republicans against. Suffice it to say that republicans don’t get many campaign contributions (or votes) from union members. Finally, consider two of SEC Chairwoman Shapiro’s key appointments to the Commission staff: senior advisor Kayla Gillian, former general counsel at Calpers, the California state workers pension fund, and Richard Ferlauto, former pension director at AFSCME, the union representing state and local government employees nationwide to the investor advocacy office.

Add it all up and it becomes clear that who benefits under the guise of shareholder democracy for all is really a limited number of unions. Now instead of spending union member’s dues in proxy contests they can lay that cost off on the corporations. It’s a nice deal if you can get it.

And Now for Something Completely Different

In the early part of the twenty-first century we all seem to lead time stressed lives. The press of business competes with the demands of ever increasing amounts of information that need to be absorbed. There never seems to enough time in the day to read everything that seems as if it might be important. So the question becomes, “How does one stay current with business thinking, or better yet, get ideas from some of the latest research?” Fortunately, technology has provided a solution.

Most people that work today spend significant time in commuting and this provides anywhere from thirty minutes to two hours a day when time is available to listen to podcasts. For those people who are not familiar with podcasts, they are electronic files that you can download to your computer, iphone and ipod and listen to anywhere, be it in the car or working out. There are an amazing variety of podcasts available, but here is a sampling of some of the better ones that that I have found that deal with business issues. Almost everything I list here is available through ITunes, and in the style of the ITunes store, I will sort them into Basics, Next Steps and Deep Cuts.

The Basics

HBR Ideacasts: Put together by the editors of the Harvard Business Review, I find this series particularly well done, with interesting topics that make me stop and think.

Freakonomics Radio: Produced by the authors of the Freakonomics books, these podcasts put an interesting spin on the dismal science.

Knowledge@Wharton Interviews: I’ve listened to relatively fewer of these as they have not been as well done as the HBR series, but there are occasional interesting interviews.

Wall Street Journal Editors Picks: Didn’t have time to read that interesting article in the Journal you saw at breakfast? You can usually get it here as the WSJ editors interview the authors of the article.

Next Steps

TED Talks: While not strictly speaking business podcasts, these speakers are engaging enough and knowledgeable enough on their subjects to get you thinking about things in a different light. Everyone engaged in business should occasionally be subject to new perspectives and these podcasts will give them to you.

BBC World Weekly with Gideon Rachman: A good way to get a non-U.S. perspective on the news events of the week, which often involve the world of business.

Stanford University Business Management: There are currently only 12 podcasts available in this series, but the ones available are quite good. (Stanford University also has a series on Business Leaders and Entrepreneurs which I have just begun listening to, which looks to be as good, but I haven’t heard enough to officially place it on the list.)

Deep Cuts

Yale Business & Management: Many of the podcasts in this series focus on very narrow topics, so you really have to hunt for what you think may be relevant to your situation, but when you find it, the speakers are quite good.

The Economist: Find the magazine too dense to read? Try the podcast.

The Bowery Boys History of New York: If you are going to deal with Wall Street, you need to understand New York and this delightful series gives you New York City history in bite-sized chunks.

And just to prove that it’s not all about business, here are some of my other favorites from my ipod.

A Prairie Home Companion’s News from Lake Wobegon: Comic genius (in a Midwestern sort of way) from Garrison Keillor.

The History of Rome: Want to know if the sex, sand and sandals in the HBO series are accurate? Listen to this podcast and catch up on your classical history.

Car Talk: Who doesn’t love Click and Clack, the Tappet brothers?

BBC In Our Time with Melvyn Bragg: Features erudite scholars being forced to speak in plain English about a variety of (sometimes) obscure topics.

Oxford Biographies: Catch up on your British history by hearing about people you’ve been told were important, but you don’t know why.

NPR Columns – Driveway Moments: Features the best human-interest stories from National Public Radio’s programming.

While everyone will have different tastes in what they want to listen to, the main point is that you don’t have to listen to that classical rock song for the 200^th time, you can actually put your brain to use and learn something useful.

Using Computers to Predict If a CEO is Lying

There is an interesting article in today’s Wall Street Journal discussing an academic paper by a couple of Stanford University Graduate School of Business professors. The article is entitled, “For Lying CEO’s, ‘Team’ Not ‘I’” and refers to a Paper entitled “Detecting Deceptive Conference Calls” available at http://www.gsb.stanford.edu/cldr/cgrp/documents/SSRN-id1572705.pdf. Obviously, for anyone involved in conference calls, either on the corporate or the investing side, this is required reading.

What the professors did was interesting: they examined the Question and Answer sessions of 29,663 earnings conference call transcripts between 2003 and 2007 for language features that predict “deceptive” reporting of financial statements. (Note that they were smart enough to ignore the carefully scripted section of the call.) In the professors’ words, “Our primary assumption is that CEOs and CFOs know whether financial statements have been manipulated, and their spontaneous and (hopefully) unrehearsed narratives provide cues that can be used to identify lying or deceitful behavior.” They then compared their predictive results to whether or not there was a later material financial restatement. And what they found was that their methodology had correctly predicted between 50% – 65% of the conference calls as “deceptive” by virtue of their having later resulted in an earnings restatement.

For those of you who want (or need) to know what the linguistic hot buttons are, here are some of the things to watch out for:

• CEOs that speak in terms of third person plural pronouns or impersonal pronouns are more likely to be deceptive. It seems in this case, honest CEOs tend to speak of I and me while dishonest CEOs prefer to refer to the company or team.
• Expressing extreme positive emotions with words such as fantastic is more likely while making a deceptive claim.
• Longer answers also are more likely to indicate that they are deceptive.
• Lack of hesitation – if a CEO is quick off the mark, the authors hypothesize that the answer is more likely one that he has rehearsed and wishes to answer quickly and move on.
• References to general knowledge such as “you know” also appear more frequently in deceptive responses.
• Lack of mention of shareholder value or value creation are also tip offs.

It will be interesting to see if investors pick up on any of this while parsing conference call answers. The Q & A session is already the portion of the call that gets the most scrutiny, and this research will only help to bring more focus to the area.

Where Did You Say You Were Going?

I’ve said it before, but it bears saying again: investors buy a company’s stock because they believe they will receive a stream of cash flows in the future from the company. They only care about past performance of the company in so far as it gives them faith that the company will perform as they expect it to perform into the future. Analysts build their valuation models based upon future earnings, not past performance. So it’s surprising to me that companies don’t say more about what their plans are for the future – how they intend to make those future cash flows.

I would not want to make a general assertion about lack of forward looking information without any data, so I decided to do a quick sample of company presentations to see how much, on average, those presentations spoke to future plans. My search took me to the Internet to look for good examples of that staple of corporate communications, the PowerPoint slide show. If you go to investor conferences, almost every presenting company will accompany its speech with a slide deck illustrating their main points. What better way to quantify what companies are saying about their outlook for the future than by counting the number of slides they have shown to investors that contain points discussing the company’s future outlook. I thought it would be a relatively easy thing to go out and pull up the presentations of the various companies and analyze what I was interested in.

To my surprise, I found that it’s not quite so easy to go out on the Internet and find a representative sample of corporate investor presentations. In fact, what I found was that in a random sample of 20 large cap U. S. companies, only five companies (25%) posted their investor presentations from conferences. (I will admit that this is a small sample size, but you get what you pay for, and you’re getting this for free.)

In examining the presentations that I did find, it became obvious that companies were much more concerned with talking about past performance than future opportunity. My methodology was simple – I counted the total number of slides in a presentation and then counted the total number of slides that contained information concerning future operations. I tried to be overly generous in what I counted as a slide concerning the future, and any slide that had even a little bit of information about what a company intended to do going forward or the outlook for their products and markets was counted as being about the future.

What I found was that the percentage of forward looking slides in presentations ranged from a low of 6% to a high of 35%, with the average for all presentations being 20%. If we assume that the information being discussed generally follows in proportion to the slides in the presentation, this means that, on average, four-fifths of all information in presentations is about current or past activities. This is the equivalent of saying, “Not much new here; we’ll just make our money by continuing to do what we’ve always done”.

Now I will be the first to tell you that the bulk of all corporate profits come from continuing operations, but that doesn’t mean that those operations remain static. We operate in a dynamic economy - markets change; competitors react; new products are introduced; the economy impacts demand for the company’s products and services; and a host of other things mean that the future will not be the same as the past. Company presentations need to take these issues into account in order to give investors a clearer picture of where the company is headed.

In short, companies should spend a little bit more time and effort talking about where they’re going as opposed to where they have been. Because those future cash flows are a crucial component that investors use to value the stock.

Tell Them Why

Following on to last week’s post about what investor relations presentations can learn from jazz, this week I take my inspiration from a different pod cast, Ted Talks. Anyone who is interested in communications should listen (the pod casts are available on ITunes) or watch Ted Talks (http://www.ted.com/), where you can find some of the best and most passionate speakers on a wide variety of topics. The TED Talks speakers have the ability to grab and hold their audiences, and if you are in the business of communicating ideas, there is no better way to learn about the process than to watch speakers such as these.

The talk that caught my attention and which I think can be instructive for people trying to get their story across to investors was one by Simon Sinek, the author of a book entitled “Start With Why”. The talk, which I gather distills the main idea of his book, offered one overarching thought, which is “People don’t buy what you do, they buy why you do it”. In a world where there are many competing products and services, the thing that distinguishes the winners and makes them appealing is the underlying passion that forms the core of their product or service. The example Sinek talked about is Apple and how they inform everything they do with a passion for combining technology, design and ease of use, but there are plenty of other examples out there. Everything Wal-Mart does is designed to deliver products to their customers at the lowest price possible. Toyota sells Lexus automobiles based upon a relentless pursuit of excellence. Whole Foods wants to deliver better and more wholesome foods.

When you start to think about this in the context of investors, who are purchasing the future stream of cash flows of your company, it starts to make eminent sense to bring to the fore the why of your company. Products, markets and service offerings change over time. Who your company is and why they do things in the manner they do changes far less often. Investors need to know what informs your basic philosophy and culture, because that is part of what they are buying: it goes into everything your company does.

Yet if you look at most investor presentations, what you find is that companies are good at telling what they do, but not why they do it. What they do is something that can be quantified or visualized. Why they do what they do is much less easy to explain. So my thought for the day is: the next time you are putting together an investor presentation about your company, stop and think about the why of your company. Is your motivation to be the very best at providing customer service, are you experts at solving technical engineering issues or perhaps you want to deliver the best combination of value and product offerings to consumers? Every company has a motivating factor and good investor relations dictates that it should be placed on display for investors to make a judgment about.

As for me, I’m passionate (and opinionated) about getting people to understand the principles of good investor relations.

What IR Presentations Can Learn from Jazz

I was working out the other day and listening to one of my new favorite podcasts, NPR’s Driveway Moments. The particular segment I was listening to featured an interview with the jazz musician Wynton Marsalis, who was explaining jazz to the uninitiated. I definitely fall into that category, as I don’t “get” most jazz. Several of the things Wynton Marsalis said caught my attention and made me think that there are some interesting parallels between some things we see in music and investor relations presentations.

Most investor presentations are set pieces: you’ve got a speaker, a set of PowerPoint slides and a bunch of information that gets disseminated over the course of 30 minutes. In this they resemble classical music. They follow a prescribed score and they don’t deviate. The speaker covers every last bullet point, just as the musicians play every note, and everyone feels safe and secure because they are on familiar ground. The speakers, similar to orchestral players, are almost interchangeable and it’s very hard to see any individuality or emotion.

This approach has some merit in that everyone navigates the treacherous shoals of regulation and potential litigation and (usually) nobody gets fired. The problem with the approach is that it’s boring and it’s not very good at getting investors excited about your company’s prospects. And investors are buying the future stream of earnings of your company, not its past deeds. Next time you’re at an investor conference, sit and listen to three or four presentations in a row. I guarantee that you will be numb at the end of the last speaker.

Contrast this with jazz. There is a structure with rhythm and melody, but there is also room for some improvisations and solos. The improvisations and solos have to fit within the framework – they don’t work if they don’t fit into the structure of the piece, but they also allow for the expression of talent and passion for the subject matter.

More passion is needed at investor presentations. Speakers should be allowed to get excited about their companies and what they’re doing. They should have a passion and a pride in their products and people and it should show through to the investing public. This is very hard to do if what you’re saying is highly scripted.

One of the masters of conveying the excitement about what he was doing was a guy I used to work with at Walgreens, Dan Jorndt. He never worked with a script, but he always knew what he wanted to say. He put things in his words and allowed his passion and pride in the company to show. Investors loved him. Another master of the art is Howard Schultz at Starbucks. Not only can he convey the romance of a cup of coffee, he is passionate about what his company stands for, from the product to the entire customer experience. If you’re ever at an investor conference and he’s speaking, take the time to go and listen to him.

Now, I can sense that many IR officers out there are squirming and thinking, “We can’t do that with our guys, they’ll go right off the rails and into the ditch”. And perhaps the approach is not for everyone. Some speakers need more structure than others, but all speakers should be allowed to exhibit what they think makes their company great. And that doesn’t come from reading a bunch of bullet points off a slide. At the very least there should be a point within a presentation where a speaker can speak from the heart, whether it’s to tell a story about an employee or a customer, or the great new product the company has developed. To put it in a jazz context, a riff or solo within the structure of the piece that serves as an exclamation point to the entire presentation. Try it – you just might acquire a taste for it.

Who Are You Going to Believe – Me or Your Lying Eyes?

Trial lawyers have a cheap, but effective trick when they catch a witness in an inconsistency. They simply ask, “Well, are you lying now or were you lying then?” I sometimes get the same feeling when I compare management statements with the risk factors disclosed in SEC filings.

For example, there was a recent blog post at Footnoted (http://www.footnoted.com/pr-spin/spinning-hidden-meanings-at-walgreen/JUNE 29, 2010) that pointed out exactly just such a discrepancy between management and the lawyers over the impact of Walgreens’ participation in prescription drug plans administered by CVS, a rival drugstore chain.

Walgreens and CVS, bitter rivals, also do business together by virtue of the fact that CVS owns Caremark, a large pharmacy benefit management company. Many prescription takers are in plans administered by Caremark, but choose to get their prescriptions filled at Walgreen retail stores. This, of course, was bound to be a troubled relationship, and sure enough, earlier this summer, Walgreens announced that it would no longer take new prescription plans administered by Caremark. After CVS, in a fit of pique then announced that it was terminating Walgreens participation in all pharmacy benefit plans, Walgreens released a statement by Kermit Crawford, executive vice president of pharmacy stating: “Regardless of CVS Caremark’s decision, we are confident of our ability to continue to grow our business as a provider in hundreds of other pharmacy benefit networks and as a direct provider to employers.”

Walgreens and CVS subsequently reached a new agreement and that was that until Walgreens filed its most recent 10-Q where, out of the blue, a new and previously undisclosed risk factor was discussed. In what seems to be a direct acknowledgement of the potential impact of losing the Caremark plans, the risk disclosure states:

“We derive a significant portion of our sales from prescription drug sales reimbursed through prescription drug plans administered by pharmacy benefit management (PBM) companies. … If our participation in the prescription drug programs administered by one or more of the large PBM companies is terminated, we expect that our sales would be adversely affected, at least in the short term. If we are unable to replace any such lost sales, either through an increase in other sales or through a resumption of participation in those plans, our operating results may be materially adversely affected.”

Now, I suppose you could say that Walgreens was merely posturing in saying that they were confident they could continue to grow their business in spite of losing the Caremark business, but that’s the sort of thing you do at the negotiating table, not in a press release. Investors expect and deserve consistency. The original statement is patently at odds with the risk statement, so I’m left with the basic question: Should I believe what you say now or what you said then?

(Full and fair disclosure: by virtue of having worked at Walgreens for over twenty years, the author has a significant financial interest in the company. I want them to get it right, which is why I get so upset when they screw up.)