items).35 Furthermore, the stock price impact of optimism is higher, the larger the number of analysts following the company and the more extensive the media coverage of the earnings announcement.Lesson: Don't hesitate to sound optimistic when warranted, particularly when the hard data like earnings or sales don't fully capture your company's performance and potential, as when earnings are depressed by large, yet promising R&D or brand-enhancing expenditures. This is important because lawyers frequently caution managers that optimism enhances exposure to litigation. Yet optimism has its rewards, as documented by Demers and Vega (optimistic persons also live longer, say researchers). But beware of baseless hype, which definitely attracts litigation. Optimism is based on facts and positive documented developments, such as a new major contract, a recent sales pickup, or a successful drug test, whereas hype is an empty ballyhoo. Recall that financial analysts and reporters will verify your optimism later on against subsequent developments, enabling them to distinguish optimism from hype.
Demers and Vega also report that a wavering, ambivalent tone (frequent use of maybe, approximately, uncertainty) is contagious too; it increases the volatility of the stock price, a reflection of investors' uncertainty.Lesson: Shielding yourself with vagueness and equivocation, which so often characterizes managerial communications, exacts a price in increased investor uncertainty and likely lower stock prices.36
Meet the Relatives: Investor Relations
On a flight to London a few years back, as I pretended to be engrossed in a book, my neighbor asked about the purpose of my trip. Giving a talk at an investor relations (IR) conference, I said, to which my neighbor, who turned out to be a CEO, responded, “We have superb IR people. They organize our press conferences and road shows well, book great hotels, and are effective gatekeepers against pestering investors and analysts.” My next-day audience was, understandably, less than thrilled to hear the CEO's “praise” of their functions. Like Rodney Dangerfield, they believe they deserve more respect. Since most medium-size and large companies have in-house IR departments, and many small firms engage IR consultants, managers would surely like to know if there is more to the IR function than the facilitation of executives' communication with investors.37 Is IR more than a glorified PR? Should we invest more in IR, upgrade its personnel, or keep it a bare-bones function? There is only scant systematic research on these important questions, but here is what we know.
IR activities are mostly aimed at enhancing the company's visibility and management's credibility in capital markets and the economic community at large: familiarizing investors with the company, its operations, performance and growth potential; targeting the desired investor base (e.g., institutional investors, sovereign funds); and attracting financial analysts to cover the company.38 Due to investors' limited attention (discussed earlier), company visibility and familiarity count a lot in capital markets. How else to explain the pervasive phenomenon known as “home bias”—the widely documented tendency of investors worldwide to invest mostly in the familiar domestic equities or in companies headquartered locally, despite the demonstrated benefits of international diversification.39 Enhancing companies' visibility, particularly of medium-size and small companies, often translates to increased demand for their securities. Wide visibility, large institutional holding, and a significant following of analysts—all objectives of investor relations—come in handy when managers issue stocks or bonds, acquire companies, or ward off activist investors and hostile acquirers. So, does IR effectively enhance a company's visibility and analysts' following, and what are the consequences of wide visibility? Brian Bushee and Gregory Miller in a comprehensive study of IR effectiveness provide interesting insights.40
Based on interviews with IR professionals, the researchers found that companies seek IR help primarily when managers believe the firm's shares are undervalued or when they want to change the composition of shareholders (e.g., increase institutional investors' share). The SEC's Regulation Fair Disclosure (2001), which prohibited restricted communication with investors, increased the demand for IR professionals to navigate public communication to capital markets. Raising the awareness of buy-side analysts and investors, said the interviewees, is the most important part of the IR function, generally aimed at creating a stable and sophisticated investor base and boosting trading activity (stock liquidity). Catering to sell-side analysts and the media follows the buy-side as IR objectives. Enhancing the credibility of managers as straight shooters is also a major target of IR, coming in handy when scandals, like earnings restatements, erupt or a proxy contest with activist investors looms. Clearly, IR professionals aspire to do more than just book good hotels for managers. But are these elevated objectives achieved with IR help?
The empirical part of the Bushee-Miller study takes up this issue. It examined a sample of 210 midsize and small companies—those with the largest potential benefit from IR in terms of visibility—that hired IR consultancies. The researchers compared the companies that hired IR consultants with a control group of companies of the same exchange listing, industry, and institutional ownership, which didn't hire IR professionals. The researchers first examined the determinants of the decision to initiate an IR activity and found once more that perceived share undervaluation and low company visibility were the major reasons for hiring IR consultants. As for the consequences of this decision, the findings will surely please IR professionals:
We find that media coverage increases almost immediately [after the IR initiation]. The increase is maintained over the next year, but does not grow over time. Analyst coverage also increases; however, it takes several quarters to develop and is not always sustained … Firms initiating IR activities experience a significant and persistent increase in both the number of institutions and the percentages of institutional ownership that is greater than for the control firms … Moreover, we document that firms initiating IR programs experience significant improvements in their market valuation … Overall, these results suggest that IR activities play a significant role in helping small and mid-cap companies to overcome their low visibility.41
But wait, before you rush to hire an IR consultant, consider first that IR is not a one-shot affair. For the positive outcomes noted by Bushee and Miller to persist, you have to maintain a sustained and costly IR effort. Since Bushee and Miller didn't match the cost of IR against the benefits, the issue of IR's cost-effectiveness is still an open one. Second, as always, statistical results are “on average”; there is no assurance that in your particular case all the documented IR benefits will materialize. Nevertheless, this preliminary research does suggest a considerable potential for IR activities to create value, particularly for small, “neglected” firms starting from a low visibility level.
And what about larger companies with ongoing IR activities? Agarawal et al. examined companies with high IR quality ratings from 2000 to 2008 in the “Best Overall IR” survey of Investor Relations Magazine, a trade journal.42 Their main finding is that companies in the “Best IR” list have a higher market value (capitalization) than similar companies not rated by the magazine, and the “best” companies also enjoyed a positive abnormal stock return (adjusted for risk, size, etc.) during the year following their appearance on the “Best IR” list. As frosting on the cake, nominated companies also saw an increase in the number of analysts following them. This is a strong endorsement of the effectiveness of IR activities, although (sorry for the downer) the documented relation between good IR and high market value could also reflect a certain reverse causal effect—from successful companies to better IR. It stands to reason that profitable companies with higher market values can better afford advanced IR activities. While it is notoriously difficult to determine causation (as opposed to correlation) with statistical tools, the relation between good IR and the subsequent increase in the number of analysts and share performance does suggest a causation, from IR to positive outcomes.
A Final Note on Visibility, Disclosure, and Stock Prices
Empirical findings, I learned long ago, have to make sense in addition to being statistically significant. How can
