2 days ago
Giving critics the cold shoulder does CEOs no favours
Few things, in financial news, make better copy than a good row between the chief executive of a quoted company and the analysts paid to follow that company's fortunes.
Plenty of well-known chief executives have become embroiled in such rows. One of the most famous came during a Tesla earnings call in May 2018 when Elon Musk interrupted Toni Sacconaghi, an analyst at Bernstein Research, who had the temerity to ask about the company's capital spending. 'Excuse me. Next,' said Musk. 'Next. Boring bonehead questions are not cool. Next?'
Joe Spak of RBC Capital Markets, who followed, received a similarly hostile reply to a question about margins: 'Sorry, these questions are so dry. They're killing me.'
More notorious still was the occasion in April 2001 when Jeff Skilling, chief executive of Enron, was asked by Richard Grubman, a fund manager at Highfields Capital Management, why the energy company had not supplied a cash flow statement. 'Well, thank you very much, we appreciate that. Asshole,' Skilling replied.
Enron filed for bankruptcy eight months later and Skilling was sentenced to 24 years in prison, later reduced on appeal.
There have also been some entertaining bust-ups with analysts on this side of the Atlantic, none more so than in August 2005, when James Eden, of Dresdner Kleinwort Wasserstein, asked Sir George Mathewson, chairman of Royal Bank of Scotland, why he thought the bank's shares were so cheap.
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Asked what he meant, Eden replied: 'There's a perception amongst some investors that [the RBS chief executive] Fred Goodwin's a megalomaniac.' Sir George was recorded as replying, under his breath: 'Shoot him.'
Some chief executives try to get around this testiness by speaking only to selected analysts. Netflix raised eyebrows when, eight years ago, it dispensed with open question and answer sessions with sell-side analysts and instead began hosting pre-recorded video interviews with just one analyst. More recently it has taken to collecting 'questions from the analyst community' which are then put to the management by the company's head of investor relations.
Similarly, Autonomy, the former FTSE 100 software company, was accused in 2009 of preventing critical analysts from asking questions on earnings calls.
The irony is that, according to research recently published in the United States, companies and their chief executives are better off taking on their critics.
Jared Flake, assistant professor of accounting at Boise State University in Idaho, analysed 101,225 earnings calls and measured the outcomes of interactions between company managers and analysts regarded as 'unfavourable' — which he defined as 'those who either have an outstanding sell recommendation or have recently downgraded their recommendation'.
He found that when a manager answered a question at length from an unfavourable analyst, that analyst was 40 per cent more likely to upgrade their rating of the company's stock than the average unfavourable analyst who did not ask a question. Flake adds: 'I find stronger stock price reactions to forecasts issued by managers who regularly interact with unfavourable analysts.'
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The length of the answer is crucial, though, as it points to an executive giving a considered answer. He found that where a chief executive gave a 'non-answer' such as 'We do not provide this disclosure', or 'I can't give you any specifics', the analyst was 11 per cent less likely to upgrade their rating than the average unfavourable analyst who received a proper answer.
Flake says: 'High quality answers, as proxied for by length, further increase analysts' tendency to upgrade … The results suggest that analysts' upward revisions result from not only the opportunity to ask questions, but also from managers' responses.'
Although interacting with unfavourable analysts does enhance a chief executive's credibility, not all those taking part in earnings calls will do so, particularly when they have discretion over how much time they allow for questions and the order in which questioners are invited to speak.
Unsurprisingly, Flake found that company executives were more likely to interact with unfavourable analysts when compelled to do so, for example after recently disclosing bad news or when a highly rated analyst covering the company was poorly disposed towards it.
Yet there are also incentives other than the share price reaction to engage with critics. Flake cites evidence that managers give greater priority to negative questions when they face higher competition, so as to highlight uncertainty and deter rivals. There is also evidence that chief executives allow more critical questions, for similar reasons, to raise their bargaining power during union negotiations. Good chief executives, Flake suggests, will also welcome the extra scrutiny from interacting more with critics because it sets them apart from peers.
There may be lessons here for the wider financial services industry. Robert Fullerton, senior research analyst at the wealth manager Hawksmoor Investment Management, observed last week, discussing Flake's research, that it was noticeable how fund managers approached him and his colleagues differently 'if for example the fund has not performed well or something isn't working'.
He added: 'The CEO/analyst interaction research suggests this and similar issues are best addressed openly, with some short-term pain paying off in the long run and a better outcome for everyone.'
Quite.
When the euro replaced legacy currencies, the distinguished financial commentator Christopher Fildes launched his Negroni Index, a way of measuring purchasing power parity. His benchmark was that the cocktail should cost the equivalent of 3,000 old Italian lira to the pound and he noted with pleasure in 2001, when sterling was riding high against the euro, that he could buy three for £10.
Fildes's index came to mind during a recent family holiday in Croatia which, since the last visit three years ago, has adopted the euro.
In August 2022 a supermarket bottle of Plavac, a popular local red wine, could be obtained for 39 old Croatian kuna — about £4.30 back then. That same bottle now goes for around €10 (about £8.60). Since sterling is only about 2 per cent lower against the euro since August 2022, the conclusion must be that joining the single currency has proved inflationary for Croatia. Either that, or the wine has got better.
