WINNING INVESTORS OVER
SURPRISING TRUTHS ABOUT HONESTY,
EARNINGS GUIDANCE,
AND OTHER WAYS TO BOOST YOUR STOCK PRICE
Baruch Lev
HARVARD BUSINESS REVIEW PRESS
Boston, Massachusetts
Copyright 2012 Harvard Business School Publishing Corporation
All rights reserved
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise), without the prior permission of the publisher. Requests for permission should be directed to [email protected], or mailed to Permissions, Harvard Business School Publishing, 60 Harvard Way, Boston, Massachusetts 02163.
Library of Congress Cataloging-in-Publication Data
Lev, Baruch.
Winning investors over: surprising truths about honesty, earnings guidance, and other ways to boost your stock price/Baruch Lev.
p. cm.
ISBN 978-1-4221-1502-2 (alk. paper)
1. Corporations—Valuation. 2. Stocks—Prices. 3. Corporate governance. 4. Intangible assets. I. Title.
HG4028.V3L4854 2012
658.15'224—dc23
2011022454
The paper used in this publication meets the requirements of the American National Standard for Permanence of Paper for Publications and Documents in Libraries and Archives Z39.48-1992.
To Ilana, Eli, and Racheli
Acknowledgments
“Capital markets are for us, CEOs of public companies, the most important thing,” the CEO of an innovative pharmaceutical company stated to me over lunch in San Francisco. Crossing the Bay Bridge back to Berkeley, I decided to write a book on this very topic: how to make the interactions between managers and investors mutually beneficial.
I thankfully received considerable assistance and support writing this book. The extensive research underlying practically every chapter was facilitated by highly capable colleagues: Richard Carrizosa, Peter Demerjian, Feng Gu, Kalin Kolev, Alina Lerman, Theodore Sougiannis, Jennifer Tucker, and Emanuel Zur. Many colleagues provided vital information, including Massimiliano Bonacchi, Mary Billings, Dan Cohen, Melissa Lewis, and Suresh Radhakrishnan.
Various experts read parts of the manuscript and enlightened me with insightful comments: Rachel Corn, Kenneth Jensen, April Klein, Sarah McVay, Richard Passov, Christine Petrovits, and Stephen Ryan. Special thanks to Gene Epstein for extensive comments on the book, extending even to its title, and for his wisdom. I was particularly fortunate to obtain the administrative support of my highly professional and dedicated assistant Autherine Allison, as well as that of the equally dedicated and professional Shevon Estwick. Nancy Kleinrock edited the manuscript very skillfully and wisely, and Jing Chen assisted with the numerous references. Joanne Hvala, Stern School’s associate dean, provided valuable marketing advice.
My rough manuscript was transformed into a much improved book by Harvard Business Review Press editor Justin Fox, who was ably assisted by Jennifer Waring, Erin Brown, Stephani Finks, and Kevin Evers at HBRP. Kirsten Sandberg, a former HBRP editor, helped me in the planning of the book.
My wife Ilana and children Eli and Rachel, to whom I collectively dedicate the book, were a constant source of encouragement and wisdom, as were our grandchildren—Netanel, Daniel, Gregory, Maor, Jason, and Michael—and daughter- and son-in-law, Ayala Lev and Tom Corn. Of these, our lovely granddaughter Daniel (age 12) provided the real impetus to conclude the book. While staying with us, she greeted me every morning with a smile and the ever-present and guilt-inducing query, “Did you finish the book already?”
Introduction
Why Restoring Investors’ Trust in Managers Is Now Critical
Capital markets during the first decade of the twenty-first century were hostile territory for investors. From the debacles of Enron and World-Com early in the decade to the collapse of Bear Stearns, Lehman Brothers, and Countrywide Financial at its end, and from the vanished investments in dot-coms and high-techs in 2000 to the massive losses of funds sunk into stocks, subprime mortgages, and commercial real estate, equity investors suffered mightily. Many corporate managers meanwhile enjoyed ever-increasing, sometimes detached-from-performance compensation, some even abusing stock option grants and helping themselves to outrageous perks and golden parachutes, all enabled by complacent, often incompetent directors. Investors’ disillusionment, ire, and loss of trust in corporate leaders were the inevitable outcome. And a seriously costly outcome it is. Consider:
Investors’ discontent brought new costly regulations: first, after the stock market collapse of 2001 and 2002, the wide-reaching Sarbanes-Oxley Act and, later, after the 2007–2008 financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act, which reached far beyond the financial sector with its “say on pay” provision, enhancing regulators’ and shareholders’ reach at the expense of managers’.
Shareholders’ and boards’ increasing impatience is shrinking the tenure of top managers. Mean CEO tenure in the United States was cut by a quarter—from eight to six years—in just the last decade. And not only in the United States. In February 2010, SAP, the world’s third-largest software producer, broke the world record for speed-firing CEOs of major companies by ousting Léo Apotheker after just nine months at the helm as sole chief (not to worry, he landed at Hewlett-Packard).
The relentless drive for director independence—the cure du jour for governance ills—and the rising number of thumbs-down votes by shareholders at directors’ elections transformed many corporate boards from managers’ counselors and advisers into supervisors and monitors, and sometimes even into adversaries. Frank information sharing and competent advice in board meetings are the victims.
Sensing investors’ discontent and managers’ loss of power, hedge funds and other activists preyed on companies to gain board seats, deplete cash reserves, and change corporate strategies. Recently, even some long-dormant mutual funds joined the activists’ ranks.
The increasing number and success of shareholder proposals and proxy contests aimed at changing corporate bylaws, separating the CEO and board chair positions, curbing compensation, as well as enacting a slew of social and environmental provisions, obviously encroach on managers’ prerogatives and restrict their decision space.
All this—primarily the outcome of investors’ and the public’s loss of trust—impinge on the ability of managers to do their jobs. The power and stature of executives have declined during the past decade, as Marcel Kahan and Edward Rock, leading law professors, document in their recent and widely read paper, “Embattled CEOs.”1 While a certain shift of
