IR Monitor – 31 May 2023

This week’s news

Activists are essential to protect shareholder value and keep management teams accountable 

A contrarian view on activist investing was offered by The Economist last week, in which the publication urged companies to look past the stereotype of the villain activist hedge funds, and to understand their essential role for shareholder capitalism. The article argues that shareholder activists possess the power to shake up stagnant companies and hold complacent executives accountable. Whilst the private equity industry is suffering from higher interest rates, this doesn’t mean that executives are out of the firing line for good. In fact, it can be argued that the pressure to apply discipline in order to see growing profits should be maintained. But this isn’t necessarily a bad thing according to the Economist. Take ESG for example: pressure for executives to respond to ESG concerns has grown significantly in the past decade. If anything, the current lull in dealmaking should be a reassurance that activists would rather see an improvement in operations rather than the board recommending a takeover offer.

Is sell side research making the cut anymore?  

It is no lie that sell-side research has been in decline over the past few decades. The rise of passive funds has driven down the profitability of active fund managers, leading to lower commissions for the sell side. Regulatory reforms like MIFID II have further impacted active fund managers’ profitability and reduced payments for sell side research, which have had to come straight out of asset manager’s own revenues. Reminiscing the so-called glory-days of sell side research, a former banker goes back to the 1990s in the Financial Times to explain why sell side research should be considered as a marketing expense more than anything else. This, he argues, is down to the fact that, as it’s increasingly difficult for banks to justify sell side research as a revenue generator, the value of the sell side is more in building relationships with investors than anything else.

UK growth companies are too high risk for too little reward for Non-Executive Directors 

In a recent study with over a hundred Non-Executive Directors, Finncap and the Quoted Companies Alliance (QCA) have revealed that the barriers which are preventing NEDs from joining the boards of smaller quoted companies could be costing these firms significant growth opportunities. The study showed that nearly two-thirds of respondents have turned down an offer to become a NED of a growing company. The research notes that this can be largely attributed to renumeration, with 94% of respondents agreeing that what smaller growth companies offer is often not competitive. For example, the granting of shares or stock options as part of overall renumeration is an incentive greatly valued in the industry, and one that is rarely seen with smaller quoted companies. Elsewhere, the study added that the role of the NED for a smaller company is fundamentally different to that of a mid-large sized business, with feedback suggesting that NEDs at smaller companies are required to offer more strategic input.

Earnings guidance provided by management teams is wrong about 70% of the time

Bloomberg mentions recent research from the University of Iowa showing that earnings guidance in the US often proves to be inaccurate. Based on a sample of 357 firms, the research demonstrates that guidance converts into reality only 30% of the time. Additional Bloomberg data supports those findings, with only 3% of companies in the S&P 500 said to have reported earnings in line with guidance most recently in Q1 2023. Surprisingly, the results are at odds with confidence levels expressed by finance managers, with around 70% of participants expressing very strong confidence (80 to 100%) in their guidance range. Researchers attribute overconfidence to hubris and miscalibration, and Bloomberg illustrates the findings with a few examples of missed guidance from Q1 2023, whilst reminding readers that a number of corporations maintained guidance in 2020, when COVID generated significant forecasting uncertainty. Guiding investors and analysts remains more than ever a perilous exercise.

What happens if retail investors start ganging up with friends and move bank stock prices?

Reflecting on recent events, Matt Levine‘s newsletter suggests that banks rely on confidence from depositors, and if people lose trust in a bank, they may withdraw their money, causing the bank to sell assets at unfavourable prices and potentially face financial trouble. The stock price of a bank is often seen as a key indicator of confidence in the company. In this context, it is plausible that retail investors on social media platforms have the potential to manipulate stock prices and profit from betting against a bank’s stock. The validity of this theory has yet to be confirmed, as there is limited evidence of retail traders specifically targeting and causing the failure of banks. The recent surge in trading activity and the rise in option volumes against regional banks suggest a growing bearish interest in the sector, the impact of a deliberate and targeted “reverse meme stock” strategy by retail investors on bank stocks has yet to be proven.

And finally… Listed companies should “see past the end of their noses”

Evening Standard’s Simon English discusses the quality of RNS announcements in the UK. He criticises the repetitive and mundane nature of corporate literature, which typically consist of dull numbers and generic quotes from chairmen that could apply to any business. The article highlights the lack of focus on people, both employees and customers, and the tendency to bury information about job cuts. It argues that companies should prioritise transparency by placing job losses at the top of announcements and concludes that RNSs provide an opportunity for companies to showcase their values and purpose beyond the next quarter’s EPS, suggesting that investors would appreciate businesses that emphasise the bigger picture.

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