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What ‘Improving Communication’ to Investors Really Means

Stephen Davis and Jon Lukomnik | August 4, 2015

for DeAnnGeorge Bernard Shaw once said the single biggest problem with communication is the illusion that it has taken place.

Shaw was a pretty good playwright. And were he alive today, he also could have a phenomenal career as a corporate official.

Today, more than ever, communication—perhaps even more than substantive action—drives myriad hot-button issues, from emerging regulation to shareowner activism. Before we explain why communication has moved front and center, let’s briefly examine the evidence that suggests communication is the frontier in the relationships between companies, regulators, and investors.

Looking first at regulation, the Securities and Exchange Commission is soliciting public comment on both audit committee disclosure and executive compensation disclosure. Meanwhile, the Public Company Accounting Oversight Board is looking at the auditor reporting model. All three initiatives have been covered extensively in Compliance Week, and we do not propose to revisit the substance of them here. What is intriguing, however, is that the primary purpose of all of them is to make transparent to investors what the companies and auditors already know. None of the three regulatory initiatives actually mandate anything other than communicating what is already known by the company.

Moving to shareowner activism, it is clear that communication has become the strategy of choice for companies facing a challenge. Last year’s Investor Responsibility Research Center Institute study found that 78 percent of companies initiated some type of engagement in the previous year. That is an all-time high level. To us, however, Camberview Partners is the conclusive piece of evidence here. Never heard of Camberview? That’s not surprising. Camberview did not exist five years ago, yet today may be the hottest corporate governance specialty consulting firm in the country; it counts at least 20 of the Fortune 100 as its clients.

What does Camberview do? Advise corporate boards and senior managements on corporate governance, particularly on how companies should tell their stories in contested situations. Business is so good that Camberview has amassed a constellation of corporate governance stars: More than 20 senior executives taken from the likes of Blackrock, Morgan Stanley, Citigroup, State Street, TIAA-CREF, Wellington, and Goldman Sachs. That Camberview has gone from non-existent to a key adviser to corporate America symbolizes the communication zeitgeist of the moment.

All this begs a question: Why now? What has changed to put the focus squarely on communication in the evolving relationship between companies and their investors?

Simply put, the power dynamic between companies and investors has changed, requiring communication to move from a one-way style of communication to two-way engagement. It’s now as much about carefully listening as persuasively explaining.

Corporate governance is no different than any other power relationship: When one party is dominant, communication is rarely a necessity. Think of the history of nations: When there is a dominant world power in a region—whether ancient Rome, 16th century Spain, colonial Great Britain, or the Soviet Union in its mid-20th  century sphere of influence—that state can dictate to other countries through conquest, colonization, war, tax policies, and other imposed force. Even when “negotiation” happens between asymmetric powers, it is far from negotiation amongst equals: Victorious nations have all the leverage in imposing treaties. Leaving aside the minority of instances when those in power want to create mutuality rather than dominance, communications and negotiations are only necessities when parties have vaguely equal power.

The power dynamic between companies and investors has changed, requiring communication to move from a one-way style of communication to two-way engagement. It’s now as much about carefully listening as persuasively explaining.

Until late in the 20th century, corporate governance power in the United States largely resided in company management, especially where firms were widely held. Everything in the relationship between the company and the investor was asymmetric. Corporations were large, investors small and disperse. Companies owned and disseminated the information; investors received it. Companies effectively selected boards of directors on behalf of investors and nominated them to classified boards featuring staggered three-year terms; under the plurality system of voting, investors had no real effective power to vote for their own representatives.

Simply put, company leaders had efficient structural ways to achieve what they wanted and therefore had little need for effective two-way communication.

Multiple factors combined to change that relationship. The ERISA law was enacted in 1973, triggering regulations that awoke and turbo-charged the ownership impact of institutional investors. New professional staffs started to equalize the resource gap between investors and the corporations they invested in. Modern portfolio theory gave rise to index investors; unable to sell their shares in underperforming portfolio companies, index funds started focusing on their voting rights as a way to improve corporate performance.

At the same time, the corporate governance movement understood the nature of the investor/company dynamic, and focused on reforms designed to equalize power. Consider, for example, how governance reformers initially focused on confidential voting, then majority voting, and now proxy access in an almost perfect incremental ratcheting up of the fight for equal power.

Broadly speaking, the investors’ battle for equal power is working. According to ISS, 2015 is the first year ever that a majority of all U.S. companies (not just the large ones) have some form of majority voting and annual elections. Power is, if not equal, at least not dominated by either companies or investors.

That is why communication has emerged as the focus of many corporate governance issues. If investors were still fractured, dispersed, and marginally empowered, there would be no need for the proposed SEC and PCAOB reforms designed to assure them that audit committees, compensation committees, and auditors have done what they were supposed to do. After all, investors would have no recourse even if convinced they had not. Similarly, Camberview exists today because companies need to explain their strategies and get investors on their side, simply because investors’ voices and votes now count for something.

The need for communication is the proof that the corporate governance power relationship has matured.

What does this imply for corporations seeking successful communications and negotiations? First, a holistic communication strategy that encompasses both governance and long-term strategy and short-term results. Too often that communication is split between the general counsel, corporate secretary, and investment relations officer.

Second, understand that investors are anything but monolithic. To best communicate with them, companies need to know which type of investors they face and who at that investor—the analyst, portfolio manager, governance professional, and so forth—wants what information.

Third, rather than merely crafting disclosure to fulfill the regulatory need, think of it as part of the strategic effort to get your investors on your side. Each year we’re struck by how much better the supplemental disclosure around compensation is at companies after they learn they have say-on-pay issues. If they can produce those persuasive arguments then, why weren’t they produced initially, to avoid the issue altogether?

Finally, true communication calls for listening. Learn what your investors want. You can ask them, read analyst reports, go to investor meetings, keep abreast of governance developments through multiple sources such as your auditing firms (all of the big ones produce periodic reports) and the American Society of Corporate Secretaries and Governance Professionals, as well as the investor-led organizations such as the Council of Institutional Investors.

Don’t be fooled by rote disclosures and one-way communications. They are what Shaw would have called the illusion of communication. Remember, the goal is to avoid the fate of Paul Newman in the movie “Cool Hand Luke,” who is fatally shot just after he notes that “what we got here is a failure to communicate.” It’s an ending companies can easily avoid.