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Corporate governance: Farce value

The relationship between companies and analysts has always been a fraught
one. And views on how the relationship works are often widely different. Some
analysts manage to stay on top of their work and do provide real insight and
understanding of what is going on. Others seem to skid by on the seat of their
pants. Basic figures will be there or thereabouts, but anything more and they
are floundering.

Companies always say that they put an enormous amount of work into investor
relations. But often what they mean is that it is an extremely time-consuming
task. And in an era of globalisation, an exhausting task such as wining and
dining across continents comes into the equation.

It is often worthwhile just to sit back and really think through what you are
trying to do with investor relations. And by that I do not mean the idea of
trying to spin one part of the business, while rubbishing another. There are
real fundamentals at risk in this game.

A recent research document from the Institute of Chartered Accountants of
Scotland, (ICAS), written by John Holland of Glasgow University, is a case in
point. Its central chapter most usefully quotes extensively from the 25
anonymous companies which shared their experiences with him.

Take this honest appraisal from a bank: “At present I would say the main
problem with the analysts is getting their interest and this is a barrier to
their understanding of the key intangibles in this business.” Or another
comment, this time from an oil company: “Fund managers do not have a lot of time
to come and see us and we need to get our message across quickly and with

Another, from an insurance company, shows vividly how close analysts come to
simply sticking a dampened finger in the air to check the way the wind is
blowing: “Fund managers are betting that the top management group will increase
the consensus down through the middle management and through the chief
executives of the strategic business units. They are betting on the qualities of
top management.”

Analysts would argue that what they are doing here is simply assessing the
senior management and thoughtfully thinking through whether they are likely to
succeed with the chosen strategy. Some quotes from a technology company suggest
that this might be true: “I think fund managers find it easy to spot top
management stars because they stand out in terms of their track record and their
strategy. They can pick out stars such as communicators and performers because
they do stand out.” On that basis all is well. The analysts are on top of their

But just four sentences later in the same testimony comes this: “However,
they can be fooled by some top management individuals who are just good
presenters. These individuals may not be very good at executing strategy. Some
fund managers cannot separate these two qualities of communications skills and
executive skills.” Small wonder that finance directors can find the whole
process wearying and sometimes both futile and time wasting.

And then there is the question of what exists and what does not. Analysts
have problems with this as well. Back to the oil company: “The package of
intangibles and promises together create a climate of confidence around the
other sources of value. They create confidence around how the existing
intangibles create value now and it creates confidence around how they are
expected to create it in the future. But this confidence is fragile, given the
information about intangibles. There is some kind of act of faith on the part of
the fund managers that these intangibles exist and contribute to value. If you
like, this confidence issue may be another component of value. It may be
possible to value it the way that loan commitments are valued by banks.”

This moves us into the world of investment fantasy. In other words, it is
about time an accounting standard was produced to provide a fair value for the
level of confidence, which myopic fund managers can be induced to create in
their own minds. The more you read the testimony in this research report, the
more you smile when you read fund managers’ reports on how robust this or that
company is.
And your smile would grow wider reading this from a retail company: “In other
words, [the fund managers] will miss out the intervening logic about value
creation and go straight to their P/E models and this is how many of these
intangibles get into the share price through such valuation.”

Now we all know that the accusation of smoke and mirrors is often levelled at
the analyst community. Often they are under too much pressure to produce an
analysis from not enough research or knowledge. But no one had suggested it was
this close to farce. Certainly the testimonies in John Holland’s research
suggest that finance directors are finding it easier to triumph over the
analysts and fund managers than they would like to let on.

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