How can companies address environmental and social problems while earning rates of return high enough to attract the capital to sustain themselves?

Sustainability and Shareholder Value

The JACF, with the support of the High Meadows Foundation, has just published the fourth (read the complete issue here) in what has become an annual series of issues devoted to the corporate “sustainability” question: how can companies address environmental and social problems while still earning high enough rates of return to attract the capital necessary to sustain themselves?

Our first sustainability issue featured corporate initiatives and investments designed to protect the environment while preserving—or, in some cases, even increasing—value for shareholders. The main focus of the second in our series was large influential investors and the growing role of “ESG” (environmental, social, and governance) criteria in their decision-making. That issue emphasized that public companies could find long-term “partners” among a small but distinguished group of “value-based” investors who have made ESG analysis a critical part of their stock valuation process.

Our third sustainability issue explained how companies could find such investors and persuade them to buy their shares. Most of the suggestions involved “integrated reporting,” a relatively new form of investor communication but one recently adopted by as widely admired a company as GE. Integrated reporting differs from the “sustainability reports” that provide exhaustive accounts of all corporate environmental and social activities. Integrated reporting instead aims to provide, within and as part of a company’s traditional financial statements, detailed accounts of only their “material” environmental and social risks—the ones that are capable of having significant effects on profitability and value.

And that brings us to the focus of this, our fourth, sustainability issue: the critical importance of identifying material corporate ESG exposures and of communicating to the capital markets both the plans to manage such exposures and their expected effects on corporate strategy and value. In our lead article, Harvard Business School’s George Serafeim and Chris Pinney, President of the High Meadows Institute, dispel a number of “myths” about ESG investing. The most prevalent, and misleading, of these myths is that ESG investors must settle for below-market returns. In reality, investors who have incorporated “material” ESG risks and opportunities into their decision-making have earned returns that are if anything higher than those earned by conventional portfolios, while exhibiting lower risk. Also in this issue, Jean Rogers, CEO of the Sustainability Accounting Standards Board, (SASB) and co-author (and former FASB head) Bob Herz discuss the practical import of SASB’s success in identifying and providing standards for corporate reporting on material ESG exposures in 79 different industries. But that success does not keep Bob Eccles and Tim Youmans of Harvard Business School from arguing that determinations of materiality are important “exercises of judgment” that should not be left to the SASB or to corporate managements. They should instead be viewed as the responsibility of corporate boards, which are urged to issue a one-page Statement of Significant Audiences and Materiality each year that explains their determinations of which exposures are material, and what the companies plan to do about them.

When we come to do our fifth sustainability issue a year from now, it will be interesting to see how many corporate boards have chosen to take this step. But even if the answer is none, the corporate share of mind for the concept of “materiality” should have increased significantly.

– Don Chew

The Rise of the Reluctant Activist

Tactics of Activist Investors

This morning’s Wall Street Journal features an article (“Don’t Make Me Do This: Rise of the Reluctant Activist”, February 19, 2016) on how many investors are adopting, even if reluctantly, the tactic of activist investors. Referring to a technology-oriented hedge fund manager:

Investor Jeffrey Osher sat on his holdings in prepaid-debit-card issuer Green Dot Corp. for three years before he lost his patience.

In December, after a string of disappointing earnings reports that left the company’s shares down sharply, the hedge-fund manager met with the board and asked directors to fire founder and Chief Executive Steven Streit, according to people familiar with the meeting. When the board refused, Mr. Osher’s Harvest Capital Strategies LLC did something it had never done before: It publicly threatened to run a campaign to oust the company’s directors.

Those moves put Mr. Osher into a newly emerging class of shareholders: Typically passive investors who are adopting, sometimes reluctantly, the tactics of activists (emphasis added).

This phenomenon was discussed at length in the Roundtable on Activist Investing published in the JACF’s Summer 2015 issue. Participants including professors from Harvard Law and Business Schools, senior decision-makers from leading hedge funds, and corporate managers with experience dealing with activist investors.

To read more and to download the issue Click here.

When to Hedge?

Hindsight is 20/20

Institutional hedging programs seem to be discussed more intensely and at higher levels of negatively affected organizations only after some major price change has taken place.

Paradoxically, price levels that seem very rewarding in hindsight rarely seemed worth protecting before the adverse price move.

For example, a January 22 article in the Financial Times “Russia considers hedging part of oil its revenues” reports that

Russia is looking at hedging a portion of its oil revenues in the future, highlighting how the collapse in prices has upended Moscow’s economic plans.

The Russian finance ministry will this year prepare the technical infrastructure necessary to implement an oil hedging programme like that of Mexico, Maxim Oreshkin, deputy finance minister, said on Friday.

The Russians are now reacting to a sharp drop in the price of its major export, crude oil. The benchmark Brent crude oil fell from over $110/barrel in mid-2014 to less than $30 recently.

As the FT story indicates, some other producers such as Mexico have long established hedging programs involving put options.

Russia has limited choices

The University of Houston’s Craig Pirrong (a regular contributor to the JACF) comments on the FT story at his blog and outlines the limited choices available to the Russians at this very late date. Craig thinks that put options, rather than swaps, are the way for Russia to go but, even this choice is complicated by the cash Russia would need now to have to pay for the puts.

Read the whole thing.

Bund for Glory, or It’s a Long Way to Tip a Market

In the Fall 2015 issue of the JACF we published a revised version of an article by Craig Pirrong called “Bund for Glory, or It’s a Long Way to Tip a Market.”

The technical details not included in this version of his article, can be found in his previous version, via the attached pdf, pages 10-28.

Bund for Glory, or It’s a Long Way to Tip a Market

To see an index of articles from the past 5 years, click here for a complete pdf.

The JACF is published by Wiley.

Where Have All the Public Companies Gone?

The U.S. Listing Gap

The number of public companies in the US has declined significantly since the late 1990s. This is the subject of a working paper, The US Listing Gap by Craig Doidge (Toronto), George Karolyi (Cornell) and René Stulz (Ohio State). While recognizing that Sarbanes-Oxley has increased the costs of being a public company in the US, they still find the extent of the decline in the US numbers to be “puzzling.”

Marc Hodak, a reader and contributor to the JACF, agrees that the numbers of public companies have declined sharply but thinks the cause is fairly evident. On his blog, he says,

Well, it’s not puzzling if you use a more realistic model of what would be driving those results. The model I have used for over a decade is quite simple:

A company will choose to be public when the benefits of being a public company exceed its costs, otherwise it will not join, or will exit, the public sphere.

The way it exits is of secondary importance.

His entire post is worth reading.

Marc addressed some of the costs of being a public company on the US in The Growing Executive Compensation Advantage Of Private Versus Public Companies in the Winter 2014 issue of the JACF, (Volume 26 Number 1).

Icahn’s Major Gains Come from Positions Held 7-10 Year or Longer

Icahn Says all of His Major Gains Have Come from Long-term Positions

In addition to Stanley Druckenmiller, Andrew Ross Sorkin interviewed legendary activist investor Carl Icahn at the Dealbook conference this week.

Sorkin asked Icahn whether activist investors contributed to managerial short-termism. The conventional wisdom is that investors like Icahn take major positions in certain companies, enjoy a jump in the share price from the surrounding publicity, and then sell off those shares after management has been forced to take actions not in the long-term interest of the firm.

Icahn replied that description simply wasn’t accurate. Far from reaping profits from short-term positions, Icahn said all of his major gains have come from positions held for 7-10 years or even longer. Mentioning specific companies he has held, Icahn described how he has interacted with managers at various companies in which he has been a shareholder. Shareholdings he continues to maintain include the following (with years held):

    ACF (31 years)
    American Railcar Industries (23 years)
    Federal Mogul (14 years)
    PFC Metals (17 years)
    Viskase (14 years)
    XO Communications (14 years)
    Vector Group (13 years)
    American Casino (11 years)
    National Energy (11 years)
    WestPoint Home (11 years)

The link to the interview is here.

For an explanation of how and why Carl Icahn became an activist investor, read The Icahn Manifesto by Tobias Carlisle in the Fall 2014 issue of the JACF (Volume 26 Number 4). For a broad discussion of corporate capital allocation issues, see Capital Deployment Roundtable: A Discussion of Corporate Investment and Payout Policy with Paul Clancy, Michael Mauboussin, John Briscoe, Scott Ostfeld, Paul Hilal, Greg Milano, John McCormack and Don Chew in the same issue.

Druckenmiller Says Earnings per Share Don’t Count

NYT Dealbook interviews Stanley Druckenmiller

On Tuesday of this week, the New York Times-sponsored Dealbook conference featured a particularly fascinating interview by columnist Andrew Ross Sorkin with well-known hedge fund manager Stanley Druckenmiller. Druckenmiller’s remarks dealt with several important issues the JACF has addressed over recent years.

On the subject of whether meeting Wall Street earnings expectations was a good thing—and “missing” earnings was a bad thing, Druckenmiller expressed great admiration for Amazon but not for IBM:

…the last 19 quarters, Amazon has missed their quarterly earnings nine times. They don’t give a damn…IBM has missed three quarters since 2006. They really care about their quarterly earnings.
[IBM] are under major attack from Amazon, Palantir, all these companies out there are eating away…Their R&D has shrunk in absolute terms and as a percentage of their sales.”
Oh yeah, I love Amazon because they’re investing in their future.

Druckenmiller said the same holds for Netflix:

“Same thing. I only heard 30 seconds of [Netflix CEO Reed Hastings]… but he said, ‘If you manage for quarterly earnings, you’re dead.’ Then somebody on CNBC says, ‘Well, it’s easy for him to say with a stock price like that.’ Well, why do you think he has a stock price like that? Because he thought about the long term and not cared about quarterly earnings and all this short-termism the whole time.”

It is unfortunate that so many business people seem to find Druckenmiller’s well-founded opinions surprising.

For a more formal and extensive treatment of exactly this topic, please read Three Common Misconceptions About Markets (or Why Earnings Smoothing, Guidance, and Concern About Meeting Consensus Estimates are Likely to Be Counterproductive) from our Summer 2013 issue, by Tim Koller, Bin Jiang, and Rishi Raj.

Some of the same ideas were expressed earlier in the JACF and actually put into practice at General Electric. See Financial Planning and Investor Communications at GE (With a Look at Why We Ended Earnings Guidance) by GE’s then CFO Keith Sherin in our Fall 2010 issue.

Don’t talk to me again until you have read this.


by Cove Street Capital on April 23, 2015

From the Web

I have been an on-again, off-again subscriber of the Journal of Applied Corporate Finance (and a predecessor) for more than 20 years. It is worth reabsorbing every few years because our ears get so full of the conventional, PR-driven crap that pours out of corporate America. Then you subscribe again, ask the management team in front of you to hold for a minute, run to the other room and throw this down and say “Don’t talk to me again until you have read this.” It’s a living.

Are U.S. Companies Underinvesting? Fall 2014 issue

The theme of our Fall 2014 issue of the Journal of Applied Corporate Finance is Are U.S. Companies Underinvesting?

In a letter he sent out to CEOs of the 500 largest companies in the U.S., Laurence D. Fink, head of BlackRock, the world’s largest asset manager, argued that too many of them have been returning capital to shareholders via dividends and share repurchases rather than reinvesting in their companies.

Fink blames activist investors for pushing management to pay out cash rather than investing for long-term value creation: “The effects of the short-termist phenomenon are troubling both to those seeking to save for long-term goals such as retirement and for our broader economy.”

Current corporate financial policies come at the expense of “innovation, skilled work forces or essential capital expenditures necessary to sustain long-term growth,” according to Fink.

During my 30-plus years as editor of the Journal of Applied Corporate Finance, I can’t think of a time when U.S. public companies were not being widely criticized for “underinvesting,” for failing to devote enough of today’s profits to increasing tomorrow’s earnings and value.

And yet, as Floyd Norris recently pointed out in his New York Times column, Misreading the Lessons From Financial Crises the stock returns of U.S. companies during the 36-year period since 1978 have been the best in American history.

In 2013 the average corporate return on invested capital for the largest 1,500 U.S. non-financial public companies reached its highest level in the last 60 years.

In our Fall 2014 issue you will find a roundtable discussion, “Capital Deployment Roundtable,” which reports that in 2013 the average corporate return on invested capital for the largest 1,500 U.S. non-financial public companies reached its highest level in the last 60 years.

For these and other discussions on U.S. corporate underinvesting, click here to purchase and download articles from our Fall 2014 issue. Don Chew, Editor.