CHAPTER 8 Post-Bubble Reality

Although there were thousands of responsible CEOs and CFOs during the

late 1990s, responsibility and accountability were certainly suspended for

some executives during the market surge. After the pin prick, the market deflated,

the government stepped in, and the communications landscape became

even more complicated. Although companies, analysts, and investors

agreed that practices needed to be amended, many of the new rules

prompted confusion and some CEOs reacted by ceasing to interact with the

market altogether. Under these circumstances, analysts struggled to unearth

nuances from flat terrain, and the capital markets slipped into a rather awkward

mating dance between investment banks and companies.

Most of the new rules hinged on the nuances of materiality. For example,

a 245-unit restaurant chain that opened one new store did not necessarily

have material information to disclose. But if this store had a prototype

kitchen model that required less labor, and could dramatically improve unit

economics if successful, then that could be deemed as material—particularly

if a system-wide rollout was in the works that could dramatically expand

margins.

Because Reg FD says that every investor has the right to know anything

material at the same time and in the same way, there are a host of ways an

executive can inadvertently make a mistake.

For example, on November 5, 2001, the CEO of Siebel Systems, a software

systems provider, spoke about a company development at an invitation-

only technology conference. Apparently, the executive thought the information

was being Web cast, but it wasn’t. Regardless, after the stock

soared, the SEC levied a fine of $250,000.

The CFO of Raytheon was cited in February 2001 for the possibility

that he released guidance to select analysts shortly after providing no guidance

publicly. He resigned as a result.

Schering-Plough paid a huge fine of a $1,000,000, and the CEO paid a

personal fine of $50,000, after he may have relayed negativity about estimates—

not verbally, but through his body language. The SEC said he violated

Reg FD “through a combination of spoken language, tone, emphasis

and demeanor.” Reg FD underscores the importance of a uniform approach

to, and a template for, disclosure, created by IR along with management.

Similarly, with management legally accountable for every assumption,

note, debit, and credit, Sarbanes-Oxley forces an eagle’s eye on every corporate

step and process. Given the time and effort required, senior executives

often find themselves reluctant to risk divulging any information until

it’s been properly weighed and measured through all the checks and balances.

IR should support this responsibility by ensuring and facilitating this

process.

SELL-SIDE IMPLICATIONS

Post-bubble, investment banking business ground to a halt and the Chinese

Wall needed to be rebuilt. The more immediate problem, however, was saving

the overall business of investment banking, in the face of what seemed to

be wave after wave of downsizings and consolidations. Industry layoffs were

extensive, exceeding 50,000 workers. Subsequently, research budgets were

slashed, research coverage decreased, and market makers—the traders on

the NASDAQ who create liquidity in specific stocks by putting their own

capital at risk—dropped their support of thousands of companies. Ultimately,

many analysts left to work for the buy-side, investment banking, or

establish their own small research boutiques.

The remaining analysts saw a new environment that included a Big

Brother-esque shadow cast by New York Attorney General Elliot Spitzer,

whose prosecution of Wall Street firms led to many of the aforementioned

reforms. As The New York Times stated in an August 17, 2003, article entitled

“An Analyst’s Job Used to Be Fun. Not Anymore,” analysts went from

being the celebrities of Wall Street enjoying all the frills and perks of being lionized,

to overworked “Wall Street everyman, content with a gray life of financial

models and spreadsheets.”

The current crop of analysts are under increased pressure to analyze

companies and sell ideas to the buy-side within a rigid process that has materially

reduced the means by which incremental information can be extracted.

These analysts now also legally guarantee their opinion and are

under intense scrutiny to pick winners and losers with equal zeal. In many

cases, they’ve received significantly reduced pay packages for one of the

toughest jobs around.

Given this new world, where the wrong email or the wrong procedure

can end a career, it’s important to understand what kind of companies attract

sell-side analysts. They are looking, first of all, for an undervalued

company that’s a good stock pick. They are also looking for a company that

“fits” their investment bank. For example, if the investment bank is a small

regional player, they don’t want their analyst to be the twenty-second name

publishing a Buy rating on Disney. What possible incremental value could

they uncover given the fact that Morgan Stanley, Goldman Sachs, Bear

Stearns, and a parade of large firms are the first to have their Disney calls returned?

Instead, the small firm typically looks for an undervalued, underfollowed

stock that the entire firm—including sales, trading, and investment

banking—can get behind.

One of the biggest criteria, however, for any sell-side firm, either large or

small, is that the analyst must believe in management and its ability to manage

The Street. Analysts will only recommend companies whose executives

they trust, executives with a firm strategy in place and an understanding of

how The Street will react to that strategy.

BUY-SIDE

Investors are as equally reliant, and wary, of the relationships they build

with the CEOs. They have millions or billions of dollars to invest, and the

most recent taste in their mouth is either a CEO who fleeced the company

or an analyst who brought them an IPO that imploded. More than ever,

these fund managers need to know that they are dealing with credible executives

who commit to communicating their results transparently, in both

good and bad times. This is the first step to credibility or, perhaps, to rebuilding

credibility.

MANAGEMENT MUST LEAD

The stock market is incredibly efficient at discounting news, and it’s impossible

to keep either good or bad news locked up for an extended period of

time. If a company attempts to do so, the executive risks information leaks

and the capital markets uncovering the information in advance of its proper

release. This is a classic example of letting the outside world define an issue

rather than the company itself defining an issue.

Therefore, in good times and bad, companies do well to communicate

quickly, thereby positioning themselves to garner a higher valuation at any

Post-Bubble Reality 47

given time. Sitting on one’s hands, locking the door, running for cover . . .

these are not solid habits of an organization that wants to attract investors

or build a relationship with the media or Wall Street.

Though Reg FD and Sarbanes-Oxley have made some CEOs skittish,

any CEO who thinks it’s better to be quiet—when bad news arises—risks

losing credibility with the investment community and key stakeholders. The

market has a tendency to negatively react in the short run to a company with

bad news. However, the news would have come out eventually, and in reality

all companies are going to have bad news. Professional investors and analysts

expect it.

As difficult as it is to stand up and reveal problems and mistakes, the

very process of doing so can help a company build credibility and dilute the

consequence of that mistake. The Street admires the executive who stands

on the frontline, addresses the issue, and gives a plan for correction. Investors,

and all stakeholders, such as employees, like to hear one voice, one

story, and a logical equation of truth that justifies their dollars, time, and effort.

Staying quiet on bad news and then being forced to answer yes, no, or

no comment can destroy credibility and valuation, and may just land a CEO

in court. For example, if the market uncovers the news, which it will, 100

savvy investors will proceed to call the CEO and CFO. When management

returns those calls they’ll be asked to comment on the rumor, and that’s

where they’re stuck.

No comment means it’s probably true.

If the CEO acknowledges the rumor as true to a specific investor, Reg

FD has been violated.

If the company denies the rumor, lying to both analysts and portfolio

managers, the CEO’s credibility is destroyed.

CEOs must work with IR to manage the release of company news so

that the dissemination of information is always within their control. Often,

if a company’s business is challenging, the environment is also challenging

for its peers. Getting out first with bad news can be a positive for the stock

and for management’s reputation. It’s the difference of being proactive versus

reactive, the latter of which is always more difficult.

The rules have opportunity written all over them. Executives need to

share the facts, show who’s in charge, and take control. Most good executives

work past the tangle of traps that have insinuated themselves into the

capital markets and strive for a policy of prompt, effective, and appropriate

communication.

An effective IR program has to counsel that the message not only be

told, but heard and interpreted in the way it was intended. This starts with

an IR program that understands the rules and the environment, and how

these fit into the perennial thinking and behavior of all capital markets’ participants.

Although there were thousands of responsible CEOs and CFOs during the

late 1990s, responsibility and accountability were certainly suspended for

some executives during the market surge. After the pin prick, the market deflated,

the government stepped in, and the communications landscape became

even more complicated. Although companies, analysts, and investors

agreed that practices needed to be amended, many of the new rules

prompted confusion and some CEOs reacted by ceasing to interact with the

market altogether. Under these circumstances, analysts struggled to unearth

nuances from flat terrain, and the capital markets slipped into a rather awkward

mating dance between investment banks and companies.

Most of the new rules hinged on the nuances of materiality. For example,

a 245-unit restaurant chain that opened one new store did not necessarily

have material information to disclose. But if this store had a prototype

kitchen model that required less labor, and could dramatically improve unit

economics if successful, then that could be deemed as material—particularly

if a system-wide rollout was in the works that could dramatically expand

margins.

Because Reg FD says that every investor has the right to know anything

material at the same time and in the same way, there are a host of ways an

executive can inadvertently make a mistake.

For example, on November 5, 2001, the CEO of Siebel Systems, a software

systems provider, spoke about a company development at an invitation-

only technology conference. Apparently, the executive thought the information

was being Web cast, but it wasn’t. Regardless, after the stock

soared, the SEC levied a fine of $250,000.

The CFO of Raytheon was cited in February 2001 for the possibility

that he released guidance to select analysts shortly after providing no guidance

publicly. He resigned as a result.

Schering-Plough paid a huge fine of a $1,000,000, and the CEO paid a

personal fine of $50,000, after he may have relayed negativity about estimates—

not verbally, but through his body language. The SEC said he violated

Reg FD “through a combination of spoken language, tone, emphasis

and demeanor.” Reg FD underscores the importance of a uniform approach

to, and a template for, disclosure, created by IR along with management.

Similarly, with management legally accountable for every assumption,

note, debit, and credit, Sarbanes-Oxley forces an eagle’s eye on every corporate

step and process. Given the time and effort required, senior executives

often find themselves reluctant to risk divulging any information until

it’s been properly weighed and measured through all the checks and balances.

IR should support this responsibility by ensuring and facilitating this

process.

SELL-SIDE IMPLICATIONS

Post-bubble, investment banking business ground to a halt and the Chinese

Wall needed to be rebuilt. The more immediate problem, however, was saving

the overall business of investment banking, in the face of what seemed to

be wave after wave of downsizings and consolidations. Industry layoffs were

extensive, exceeding 50,000 workers. Subsequently, research budgets were

slashed, research coverage decreased, and market makers—the traders on

the NASDAQ who create liquidity in specific stocks by putting their own

capital at risk—dropped their support of thousands of companies. Ultimately,

many analysts left to work for the buy-side, investment banking, or

establish their own small research boutiques.

The remaining analysts saw a new environment that included a Big

Brother-esque shadow cast by New York Attorney General Elliot Spitzer,

whose prosecution of Wall Street firms led to many of the aforementioned

reforms. As The New York Times stated in an August 17, 2003, article entitled

“An Analyst’s Job Used to Be Fun. Not Anymore,” analysts went from

being the celebrities of Wall Street enjoying all the frills and perks of being lionized,

to overworked “Wall Street everyman, content with a gray life of financial

models and spreadsheets.”

The current crop of analysts are under increased pressure to analyze

companies and sell ideas to the buy-side within a rigid process that has materially

reduced the means by which incremental information can be extracted.

These analysts now also legally guarantee their opinion and are

under intense scrutiny to pick winners and losers with equal zeal. In many

cases, they’ve received significantly reduced pay packages for one of the

toughest jobs around.

Given this new world, where the wrong email or the wrong procedure

can end a career, it’s important to understand what kind of companies attract

sell-side analysts. They are looking, first of all, for an undervalued

company that’s a good stock pick. They are also looking for a company that

“fits” their investment bank. For example, if the investment bank is a small

regional player, they don’t want their analyst to be the twenty-second name

publishing a Buy rating on Disney. What possible incremental value could

they uncover given the fact that Morgan Stanley, Goldman Sachs, Bear

Stearns, and a parade of large firms are the first to have their Disney calls returned?

Instead, the small firm typically looks for an undervalued, underfollowed

stock that the entire firm—including sales, trading, and investment

banking—can get behind.

One of the biggest criteria, however, for any sell-side firm, either large or

small, is that the analyst must believe in management and its ability to manage

The Street. Analysts will only recommend companies whose executives

they trust, executives with a firm strategy in place and an understanding of

how The Street will react to that strategy.

BUY-SIDE

Investors are as equally reliant, and wary, of the relationships they build

with the CEOs. They have millions or billions of dollars to invest, and the

most recent taste in their mouth is either a CEO who fleeced the company

or an analyst who brought them an IPO that imploded. More than ever,

these fund managers need to know that they are dealing with credible executives

who commit to communicating their results transparently, in both

good and bad times. This is the first step to credibility or, perhaps, to rebuilding

credibility.

MANAGEMENT MUST LEAD

The stock market is incredibly efficient at discounting news, and it’s impossible

to keep either good or bad news locked up for an extended period of

time. If a company attempts to do so, the executive risks information leaks

and the capital markets uncovering the information in advance of its proper

release. This is a classic example of letting the outside world define an issue

rather than the company itself defining an issue.

Therefore, in good times and bad, companies do well to communicate

quickly, thereby positioning themselves to garner a higher valuation at any

Post-Bubble Reality 47

given time. Sitting on one’s hands, locking the door, running for cover . . .

these are not solid habits of an organization that wants to attract investors

or build a relationship with the media or Wall Street.

Though Reg FD and Sarbanes-Oxley have made some CEOs skittish,

any CEO who thinks it’s better to be quiet—when bad news arises—risks

losing credibility with the investment community and key stakeholders. The

market has a tendency to negatively react in the short run to a company with

bad news. However, the news would have come out eventually, and in reality

all companies are going to have bad news. Professional investors and analysts

expect it.

As difficult as it is to stand up and reveal problems and mistakes, the

very process of doing so can help a company build credibility and dilute the

consequence of that mistake. The Street admires the executive who stands

on the frontline, addresses the issue, and gives a plan for correction. Investors,

and all stakeholders, such as employees, like to hear one voice, one

story, and a logical equation of truth that justifies their dollars, time, and effort.

Staying quiet on bad news and then being forced to answer yes, no, or

no comment can destroy credibility and valuation, and may just land a CEO

in court. For example, if the market uncovers the news, which it will, 100

savvy investors will proceed to call the CEO and CFO. When management

returns those calls they’ll be asked to comment on the rumor, and that’s

where they’re stuck.

No comment means it’s probably true.

If the CEO acknowledges the rumor as true to a specific investor, Reg

FD has been violated.

If the company denies the rumor, lying to both analysts and portfolio

managers, the CEO’s credibility is destroyed.

CEOs must work with IR to manage the release of company news so

that the dissemination of information is always within their control. Often,

if a company’s business is challenging, the environment is also challenging

for its peers. Getting out first with bad news can be a positive for the stock

and for management’s reputation. It’s the difference of being proactive versus

reactive, the latter of which is always more difficult.

The rules have opportunity written all over them. Executives need to

share the facts, show who’s in charge, and take control. Most good executives

work past the tangle of traps that have insinuated themselves into the

capital markets and strive for a policy of prompt, effective, and appropriate

communication.

An effective IR program has to counsel that the message not only be

told, but heard and interpreted in the way it was intended. This starts with

an IR program that understands the rules and the environment, and how

these fit into the perennial thinking and behavior of all capital markets’ participants.