Baruch Lev

New York University

blev@stern.nyu.edu

www.baruch-lev.com

August 2012 © Baruch Lev. Please do not reproduce this presentation or

part of it without author’s written permission.

WHY WINNING INVESTORS IS STILL

IMPORTANT AND HOW TO DO IT

Why Capital Markets Are Important 2

Everyone talks about growth, but where will the funds for investment in growth come from? Governments are broke Banks are not lending

Stocks and stock options provide important incentives for managers and employees. But for the incentives to work, the company’s shares should out-perform.

Under-performing shares attract intervention by activist investors and hedge funds, threatening managers’ authority and position.

Capital markets—the only reliable and cheap source

Ignoring the stock market will adversely affect

your performance and career.

So, Winning Investors Over is Important,

But it is Not Easy 3

Investors world-wide are frustrated and angry because:

They just endured the worst stock market decade in

recent history,

They constantly hear about corporate failures and

accounting scandals

And about managers receiving high salaries and

bonuses while company shares are declining.

And investors react: Demand regulations (say on

pay), increase activism, and run away from stocks.

4

Read my book.

5

Listen to investors: There are important messages in

shareholder resolutions, hedge fund demands,

institutional sales, short sales, and falling share prices.

Provide information that investors really need:

Accounting is increasingly irrelevant; investors need

business model information, prospective information

Don’t “manage” information: Earnings management

(manipulation) is widespread in the U.S., Asia and

Europe. Stopping this is key to winning investors over.

Seriously:

6

Communicate effectively: Research lessons on how to

enhance managers’ communication with investors

Link managers’ pay to performance: Too many

companies practice pay-for-no-performance, nothing

more angers and alienates investors.

Do corporate social responsibility (CSR) responsibly:

The biggest bang for the buck—using the company’s

specialized capabilities in CSR.

Continued

7

Investors React Enthusiastically to

Hedge Funds’ Investment

Source: Brav, Jiang, Thomas and Partnoy, “ Hedge Fund Activism, Corporate Governance,

and Firm Performance.”

Important Messages from Investors 8

Pay close attention to the messages in:

Falling share prices

Decrease in institutional investment

Increase in “short interest” (short sales)

Increase in share volatility

Shareholder resolutions

The Shrinking Role of GAAP Enhances the

Importance of Non-GAAP Information

Source: B. Lev, Winning Investors Over (2012).

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1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

Ad

j. R

2

Reflection of Earnings and Book Values in Share Prices

10

No secret plans, no flights of fancy, no litigation.

Period

Acquisition

cost per

customer

Net

subscriber

increase

Monthly

churn

Revenue

from new

subscribers

Customer

lifetime

value

First quarter

2008

$29.50 764,000 3.9% $32.3 million

(9.9%)

$730 million

Fourth

quarter 2007

$34.60 451,000 4.1% $19.2 million

(6.3%)

$683 million

First quarter

2007

$47.46 481,000 4.4% $22.9 million

(7.5%)

$696 million

Relevant Information Depends on the

Business Model 11

Innovative companies

Brands-intensive companies

Connected companies

R&D breakdowns and

acquired technology Patent attributes ,

trademarks, product

pipeline

Innovation revenues,

cost savings

Investment in brand-

creation and

enhancement

Trademarks, repeat

customers, customer life-

time value

Brand revenues,

market share

Consequent patents,

trademarks, new

products

Investment in alliances

and joint ventures Related revenues and

cost savings

12

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60-day Moving Average Ending

Pre Monthly Release

Average = 2.12

(April 1996 - April 2001)

Post Monthly Release

Average = 1.22

(May 2001 - Sep 2004)

Volatility Decreased with

Monthly Financial Releases

Source: Bloomberg Source: Progressive

Widespread Earnings “Management” to

Beat the Consensus

Source: Bhojraj, Hribar, Picconi, and Mcinnis. 2009 “Making Sense of Cents: An Examination of Firms

That Marginally Miss or Beat Analyst Forecasts,” Journal of Finance

13

The Distribution of Earnings Surprises

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Earnings Management Around the World

Earnings Management is a Waste of Time

Source: Bhojraj, Hribar, Picconi, and Mcinnis. 2009 “Making Sense of Cents: An Examination of Firms

That Marginally Miss or Beat Analyst Forecasts,” Journal of Finance

15

Effective Investor Communications 16

Cut the bullshit

Fewer words, more numbers

More “hard numbers”: standardized measures

(order backlog vs. customer satisfaction); verifiable

targets (sales forecast vs. environmental targets);

Less managerial talk, more questions & answers

Let other executives—not just CEO and CFO—talk

Continued 17

Take a clear stand

Wavering, hedging, uncertain expressions (maybe,

perhaps, it depends) decrease communication

effectiveness

After a disappointing period, face up to the

situation—explain clearly what happened and

what corrective actions you are taking

Avoid empty expressions and sugarcoating (we look

forward to a great year, we are confident about

the future)

Continued 18

And other good suggestions

Early morning conference calls and investor meetings

Provide honest forward-looking information, if

possible

Engage as many analysts and investors as possible

Honesty above all!

19

The Very Weak Link between Managers’

Pay and Company Performance

Finally, Corporate Social Responsibility

20

No doubt—corporations need to conduct their business legally and ethically.

But, what about financial contributions to civic, social, environmental, or political causes?

Milton Friedman: Corporate funds belong to shareholders, and they should decide how much and to whom to give

My exception: Using the specialized capabilities of companies to do good: Cisco—Networking Academy

Home Depot—KaBoom!

TNT, NV Logistics

Last Word: 21

Doing the above will not only get investors

on your side, but will also enhance your

career and make you feel better.