Introduction to Investor Relations

By John Palizza

This book is a basic introduction to investor relations originally designed for use by MBA students. It covers the interaction between finance, the laws and regulations surrounding how companies deliver their message to investors, the financial valuation of companies and communications issues faced by companies. It is helpful for those who practice investor relations and want a concise guide to how investor relations impacts corporate valuation, how marketing helps you understand financial communications, whether and when to issue guidance,the laws and regulations surrounding investor relations, what the academic research has to say about investor relations and various practical issues that arise in the profession.

• Language: English
• Publisher: Lulu.com
• Release date: Feb 11, 2015
• ISBN: 9781312911666

Book preview

Introduction to Investor Relations

Introduction to Investor Relations

John Palizza

 John M. Palizza, 2012.  All rights reserved.  No part of this manuscript may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information and retrieval system, without written consent of the author.          ISBN 978-1-312-91166-6

Chapter 1

Investor Relations: A General Overview

The daily value of stock traded on the world’s equity exchanges is in the trillions of dollars. The value of those equities is directly affected by the flow of information between listed companies and investors, a process commonly referred to as investor relations. This work is devoted to examining the practice of investor relations.

Definition

Investor relations is the process of a company conveying appropriate information to investors in order to allow them to make an informed investment decision regarding that company.

It is a discipline that sits at the intersection of marketing, finance, communications, law and the capital markets. It is a continuous process that has as its aim presenting a clear and accurate depiction of the past performance of the company, its current state and its future prospects. If done correctly, investor relations builds an audience for the company’s shares, allows a company’s stock to achieve appropriate valuation in the equity market, aids the company’s stock in trading with a reasonable amount of liquidity and, for future issues, achieve easier and cheaper access to the capital markets.

Although how investor relations interacts with marketing, finance, communications, law and the capital markets will be explored at greater length throughout this work, a brief discussion of each is in order at this point. Marketing in investor relations refers to the process of understanding investors’ investment philosophies, needs and restrictions so that the message will be delivered to the audience where it will be best received. The finance requirement in investor relations refers to the fact that much of the information transmitted in investor relations is financial in nature and the investor relations officer needs to be able to explain the ramifications of the reported numbers, from the simple income statement entry to more complicated accounting treatments such as pension accounting. The capital markets are the mechanisms by which stocks are valued, so an investor relations officer needs to understand how they operate. The communications discipline is important in delivering the message in the appropriate format with the maximum effect. Finally, all investor relations is circumscribed by statutes, regulations and case law and it is vitally necessary to operate safely within that framework.

A Balanced Message

Thinking of investor relations in this fashion allows us to focus on the influence of the various aspects of investor relations. If the message veers too much into the realm of marketing and communications, the message begins to resemble public relations and credibility with the sophisticated, financially savvy institutional investor suffers. If, on the other hand, the message is dominated by the law and finance side of the equation, one winds up with a dry, uninteresting document that resembles a filing with the Securities and Exchange Commission. The ideal is a balanced message that incorporates all of the necessary information and which is delivered in a clear and understandable way within the legal requirements of the securities laws.

Figure 1-1 below illustrates the ideal.

Figure 1-1

What Investor Relations is Not

At this very early point we should also state what investor relations is not – that is, investor relations is not a cheerleading function. Nor is it the mechanism by which you get the stock price up. The market will quickly see through efforts to inflate a company’s prospects when reality does not live up to expectations. Further, the consequences of an over priced and over-hyped stock are almost always bad in the long run. If a company’s stock price has diverged from its intrinsic value, the result will be either a stagnant stock price for a period of time until earnings catch up with the inflated expectations, or a sudden downward revaluation of the stock price. Neither is a pleasant experience. Thus, the emphasis in investor relations should be on achieving a fair, sustainable valuation for the company’s stock.

A Preliminary Framework

Traditional financial theory holds that the value of a firm is equal to the sum of the cash flows from its stock, discounted back to present value. This means that the investor relations officer of a company must be able to express to the equity market a company’s future prospects so that investors can make reasonable estimates of future earnings. Additionally, except in the case of a brand new venture, such future prospects do not occur in a vacuum and investors will take past performance into account in order to judge the likelihood of achieving the firm’s future prospects. A simple framework for thinking about how this valuation works is:

Past Performance

+= Current Stock Price

Perception of Future Performance

In other words, the valuation of future cash streams coming from the company is filtered through an examination of what the company has done in the past. The consistency with which a company’s management has achieved its goals in the past plays a large part in how investors evaluate management’s ability to deliver on future promises.

The Flow of Information in Investor Relations

Mandatory Disclosures

The process of delivering information to investors and potential investors is one of selection and discretion. Within a corporation, an investor relations officer starts with a plethora of information regarding the company’s markets, revenue streams, expense structure and accounting treatments. From this, information must be extracted for disclosure to the investing public to comply with governmental regulatory requirements and the contractual requirements of the stock exchanges. In the United States, the statutes, and in particular the regulations accompanying them and promulgated by the Securities and Exchange Commission are quite extensive and are designed to give investors a fairly clear understanding of a company. These mandated disclosures form the basic framework of modern investor relations.

Voluntary Disclosures

Just as the framework of a building does not show the completed structure, the minimum disclosures required by laws and regulations do not always paint a complete picture of a corporation for investors.  Most companies elect to add clarifying detail about their operations in the form of additional voluntary disclosures, regarding both past performance and reasonable estimates of future prospects. Appropriate additional disclosures will attempt to place the company within the context of the industry and markets within which it operates, give investors some insight into how the company thinks about its business and discuss some of the key performance metrics the company uses to measure its progress. Insights into key management personnel through presentations and face-to-face meetings are also important voluntary disclosures, allowing investors to make judgments about management.

Channels of Communication

Once an investor relations officer has determined the appropriate amount of detail to release to the markets, he must consider the appropriate means of transmitting the message. The channels for disseminating the message vary widely but fall into four broad categories: governmental filings, financial press releases, mass media and personal delivery of the message. Choosing the appropriate means of delivering the message is one of the responsibilities of the investor relations officer, and the method of delivering the message is in turn influenced by the intended audience. Of necessity, investor relations has to deal with a variety of audiences, from sophisticated institutional investors, to individual retail investors and to employees. Additionally, many other entities will have an interest in learning about the business, including the firm’s creditors, competitors, customers and governmental agencies having oversight of the firm’s business. In addition to these traditional audiences, in recent years special interest groups have also become an important consideration in crafting a firm’s public profile. These groups include associations focused on issues such as corporate social responsibility issues where the focus may be on the environment; corporate governance, where the emphasis is on the management of the firm; or issues specific to an industry or firm such as labor relations or globalization.

In the practice of investor relations, the message is not always delivered directly. Information intermediaries often play an important role in disseminating the past performance and future prospects of an organization. Generally, these intermediaries fall into three groups: Sell Side equity analysts, rating agencies and the media, both financial and general. A quick, but admittedly oversimplified way of thinking about the audiences each of these intermediaries serves is as follows:

Sell Side equity analysts principally serve large institutional investors, and to a lesser extent, individual retail investors;

Rating agencies mostly serve holders of the company’s corporate debt and to a smaller degree, equity holders who use the debt rating as a measure of the company’s risk;

The financial media has an audience mostly comprised of people who are directly interested in corporate financial results, with a smaller component of a general interest audience; and

The general media addresses the mass-market audience and will usually include customers, competitors, employees and individual shareholders.

Credibility and Firm Visibility

The credibility of a firm and its management is absolutely critical to successfully getting the message across to investors regarding a company’s future prospects. Credibility is built up over an extended period of time through a variety of actions, including consistent performance in financial results, following through on doing what the company said they were going to do, and clear and honest communications.

The visibility of a firm and the amount of attention it commands in the financial and general media also have a direct impact on the effectiveness of an investor relations program. Too little visibility and your message may not get to the intended audience. Too much visibility and a firm will find that it may have attracted many constituencies that may have agendas that conflict with the aims of the corporation, causing distractions.

Actions Influenced By Investor Relations

While it may seem obvious that the principle action influenced by investor relations is whether or not to purchase a stock, there are in actuality a number of audiences and ancillary actions that need to also be considered. Of primary importance are potential actions by existing shareholders: continue to hold the stock, buy/don’t buy more stock, or sell current holdings. Existing shareholders have already done extensive research regarding the company, are known by the company and therefore should never be ignored. Investors new to the company will often require extensive investment of time and effort to become comfortable with the investment prospects of the company in question and should therefore come second on a priority list of investors, although certainly their buy/don’t buy decisions are extremely important.

In addition to these basic actions by shareholders, the effect of investor relations on employee morale is probably the next most important audience to consider. Employees have a strong vested economic interest in the performance of the company. The future prospects of the firm impact their jobs and their career prospects. Many will own stock themselves. Where the firm is going and how it intends to get there are always of great interest to employees.

If the only factor to be considered in corporate disclosure were stock performance, the answer would be clear: tell everything you can to investors to eliminate the fear of information asymmetry and give them maximum confidence in management. Unfortunately, in the real world many other factors come into play. First, regulations are such that in many jurisdictions, companies must be very circumspect in their statements, particularly product claims or forward-looking projections, in order to avoid falling afoul of regulations. The securities markets are highly regulated in most countries and the prohibitions range from forbidding companies from offering to sell stock except in connection with a formal offering document, to the nature and timing of important announcements. Hence most corporate disclosures tend to be heavily edited documents that shy away from forward-looking statements.

Second, there are other audiences to consider. Too much disclosure may tip off a company’s competitors as to the strategic direction of the firm, nullifying the advantage of surprise and first mover status. Suppliers, creditors, bond holders and debt rating agencies will also be paying attention to what the company has to say about its future prospects. If they don’t like what they hear the result may be a higher cost of debt, a lack of credit in the markets or the inability to obtain products from suppliers. Customers will also be a paying attention to see how the company’s future plans may conflict with their needs.  Finally, governmental entities such as antitrust regulators will have an interest in the company’s remarks.

All this is to say that while full and complete disclosure of company plans is an ideal to be strived for in maximizing a company’s valuation, a fine line must be walked in order to navigate the conflicting