Month: October 2018

Building a Bridge between Marketing and Finance

How advances in behavioral science and financial analytics offer an effective way to bridge this gap between marketing and finance.

Our fourth article from the (JACF Spring/Summer issue) discusses how finance executives are often frustrated by spending proposals from their marketing colleagues but cannot seem to be able to quantify the putative benefits. Similarly, the marketing staff is frustrated by the finance team’s inability to convert soft marketing metrics, such as “awareness” and “customer satisfaction” into financial forecasts. The challenge is that neither marketers nor finance executives have been able to articulate a single analytical framework which both explains how and why brands come to flourish or flounder and how brand growth contributes to the business’s short and long term bottom line.

Lacking an effective way to do this now, most managers default to using the hard data they do have, namely how marketing investment is likely to impact sales this quarter and next. This reinforces the widespread focus on quarterly EPS and reduces the perceived value of the marketing department to their ability to hit three month sales targets. This degraded view of marketing’s contribution and the inability to link “soft” marketing metrics to longer term financial returns impedes building long-term brand value. This article focuses on how advances in behavioral science and financial analytics offer an effective way to bridge this gap between marketing and finance.

Building that bridge requires better measures of brand health and financial performance to allocate capital and marketing resources. Undoubtedly, brand building is both an art and a science. But, the finance people can develop an evidence-based framework explaining how some of the “softer” investments such as brand building, contribute to the value of the firm.

Authored by Ryan Barker, BERA Brand Management, and Greg Milano, Fortuna Advisors

The ESG Integration Paradox

The ESG Integration Paradox

Our third article from the JACF Spring/Summer issue is by Michael Cappucci.

Today, most investment managers have something to say about environmental, social and governance (ESG) issues, and written ESG policies are ubiquitous.

Today, most investment managers have something to say about environmental, social and governance (ESG) issues, and written ESG policies are ubiquitous.

Yet, a written policy is not a reliable indicator of a firm’s commitment. Actual ESG incorporation practices vary greatly, with most investment managers falling well short of full integration. Only a few firms seem to be using ESG factors to deliver alpha, hence, the paradox. If not implemented wholeheartedly, responsible investing can lead to lower financial returns. So, why have so few investment managers gone all the way?

The paradox involves a “valley” of lower returns where portfolios first absorb the costs of ESG integration before the promised benefits materialize. In the early days of ethical investing, the focus was on using negative screens to exclude certain companies for moral or ethical reasons but lower financial returns are inherent to exclusionary screening.

Hard exclusions force managers to tradeoff certain risks for others. So, for example, if the market discounts tobacco stock prices to account for changing consumer behavior, eventually tobacco stock prices become attractive again as, indeed, has been the case over the last two decades. Exclusionary screening alone is a self-limiting strategy.

By contrast, ESG strategies range from active ownership and engagement, to positive screening (selecting for certain attributes), to relative weighting (sometimes called “best-in-class selection”), to risk factor investing, to full integration.

Because the relationship between an asset manager’s ESG efforts and its risk-adjusted performance is not classically linear, asset owners should look for managers that are on the upward slope of the ESG intensity curve and are fully committed to advancing up it.

Authored by Michael Cappucci, Harvard Management Company

‘The Big Four’ Review: Titans of the Books

‘The Big Four’ Review: Titans of the Books

Wall Street Journal, Book Review, September 24, 2018

The mightiest accounting firms now scorn their traditional core business of auditing and have taken to “consulting” like ducks to water. Jane Gleeson-White reviews “The Big Four” by Ian D. Gow and Stuart Kells.

By Jane Gleeson-White
Sept. 23, 2018 1:32 p.m. ET

Deloitte, EY, KPMG and PwC are among the best-known brands in the world. These “Big Four” accountancy firms are international organizations which together generate revenues of more than $130 billion annually and employ almost 1 million staff. Despite their modish names with hip abbreviations and the stylish typography of their logos, each firm can trace its origins to 19th-century Britain. Take PricewaterhouseCoopers: Samuel Price started practicing in 1848, and William Cooper in 1854. William Deloitte began in 1845. The earliest ancestor organizations of Ernst & Young and KPMG were also founded in England.

In “The Big Four,” Ian Gow and Stuart Kells, with a characteristically light touch, observe that the 19th century was the accounting profession’s “ ‘wild west’ era, even more so than the 1980s.” Samuel “Sammy” Price was a “rule-breaking, lumbago-suffering oddball.” From a family of potters, he could work his hands in more than one respect: As a “fan of prize fights, streetfights and indeed any kind of fight, he was not averse to joining in himself.” Edwin Waterhouse was a member of the Religious Society of Friends—that is, a Quaker. His Quakerism shaped his view of himself as “a ‘Christian gentleman’ responsible for delivering an important social service.” His son Nicholas, however, threw “very un-Quaker-like” parties in his Chelsea home that featured “drugs as well as sex.”

The boom in British railways fueled the need for financial rigor, and as the law increasingly required accounting for the conduct of commerce, the small firms flourished and merged to meet the demand for auditing, annual reporting, and liquidation. In the century and a half since, their descendant firms have expanded globally and survived fraud, lawsuits and scandals. Yet unusually in these times of transparency, the inner workings of the accounting giants remain shrouded from view.

“The Big Four” is not so much the history of these institutions as a brief tour of accounting’s past, from its origins in Renaissance Italy to the current era of mega-firm dominance. The authors are well-placed to examine this history. Mr. Gow has worked for Morgan Stanley and other multinationals, has taught at Harvard Business School and is now a professor at the University of Melbourne. Mr. Kells has been a director of KPMG, as well as an assistant auditor-general of the state of Victoria in Australia.

Their pacy prelude opens with the 1880 founding of the world’s first national accounting association, the Institute of Chartered Accountants in England and Wales, and then canvasses the origins of modern accounting via three formative books acquired by the organization for its library. One is Luca Pacioli’s 1494 “Summa de Arithmetica,” which includes the first printed treatise on double-entry bookkeeping. The other two, published in 16th-century Antwerp and London, reflect double entry’s movement west across Europe.

The authors argue that the institute’s collection of such books is a monument to the principle “that sound bookkeeping is the foundation of success in statecraft and in commerce.” The Big Four reached the pinnacle of their profession by trading on a widespread belief in this idea; the authors then explore how well-founded the public’s faith in these institutions is today.

The book is divided into four parts whose titles convey its argument: “Infancy’” “Maturity,” “The Difficulties of Adulthood” and “The Twilight Years.” The first two sections take us from the Medici Bank through the rise of the Big Four. But the authors hit their stride in part three, which covers the postwar years, when the firms made auditing the books of major corporations into the basis of their brands. Recently, the authors note, auditing has become undervalued and scorned within the four fiefdoms. Instead, they have taken to “consulting” like ducks to water.

Messrs. Gow and Kells believe the Big Four are endangering their futures by neglecting their one-time core business. They point out that the corporate collapses and scandals of the early 21st century—most spectacularly Enron, which brought down its adviser and auditor Arthur Andersen—led to a regulatory response “focused largely on the role of the auditor.” In the United States, the Sarbanes-Oxley Act of 2002 didn’t prevent “a string of similar-sized calamities” during the 2008 financial crisis.

As the authors observe, each of the Big Four was linked to “some of the most spectacular failures. Deloitte had audited Bear Stearns and Fannie Mae. KPMG had audited Citigroup. PwC had audited American International Group and Goldman Sachs. EY had audited Lehman Brothers.” These examples challenge the mistaken view of outsiders that audited accounts are trustworthy.

In part four, “The Twilight Years,” the authors assess the threats to the supremacy of these giants from “smaller players with low overheads and high agility.” But they also take us back to a story begun earlier in the book, that of the unraveling of the Medici Bank, which is offered as a sort of precursor to the Big Four. What the two stories share, the authors suggest, is the dilution of an original purpose: “Focus had been at the heart of the Medicis’ success,” they write. “Gradually, though, they had forgotten their core business.” The book’s analysis of the causes of the Medici Bank’s collapse—defaults by profligate borrowers, increased appetite for risk, failure to oversee the bank’s distant franchises and a departure from the organization’s core business—offers a salutary lesson for the Big Four today.

While there is still a larger, more detailed history of these firms to be written, Messrs. Gow and Kells have made an invaluable contribution, writing in an amused tone that nevertheless acknowledges the firms’ immense power and the seriousness of their neglect of traditional responsibilities. “The Big Four” will appeal to all those interested in the future of the profession—and of capitalism itself.

Ms. Gleeson-White is the author of “Double Entry: How the Merchants of Venice Created Modern Finance.”