Just Say No To Wall Street's Pressure For Growth & Poor Risk Management
Abstract (Via Dartmouth)
CEOs are in a difficult bind with Wall Street. Managers up and down the hierarchy work hard at putting together plans and budgets for the next year and quite often when those plans are completed top management discovers that the results fall far below what Wall Street expects. CEOs and CFOs are therefore left in a difficult situation. They can stretch to try to meet Wall Street’s expectations or prepare to be punished if they fail. All too often top managers react to the situation by encouraging or mandating middle and lower level managers to redo their forecasts, plans and budgets to get them in line with external expectations. In some cases, fearing the results of missing the Street’s expectations, managers start the budgeting process with the consensus expectations and mandate that internal budgets and plans be set so as to meet them. Either way this sets the firm and its managers up for failure if external expectations are, in fact, impossible for the firm to meet.
We illustrate, with the recent experience of Enron and Nortel, the dangers of conforming to market pressures for growth that are essentially impossible. We emphasize that an overvalued stock can be as damaging to the long-run health of a company as an undervalued stock, a proposition that few managers are familiar with. An overvalued stock sets in motion a variety of organizational behaviors that often end up damaging the firm. It does not have to be this way. Ending the “expectations game” requires that CEOs reclaim the initiative in terms of setting expectations and forecasts. To begin, CEOs must say no to the “earnings guidance” game and reverse recent practices in which analysts took the lead in driving industry forecasts, and companies complied. Managers must make their organizations more transparent to investors, so that stocks can trade at close to their intrinsic value. Doing so means CEOs and CFOs must inform the market when they believe the market expectations cannot be met and that the stock is, therefore, overvalued.
Interesting Excerpts (Via Dartmouth)
Last year, the Securities and Exchange Commission recognized that private conversations between executives and analysts had become extensive, with analysts gaining access to critical data not otherwise available to shareholders broadly. The new regulations insisting on fair disclosure addressed the mechanics of the conversation, but did little to change its underlying logic. The result, at best, has been blizzards of filings, dozens of press releases, and many more company-run conference calls.
Many will say, “So, what? If overly aggressive analysts drove executives to create more shareholder value faster, what’s the harm?” What they fail to recognize is that this vicious cycle can impose real, lasting costs on firms when analyst expectations become unhinged from what is feasible for firms to accomplish. As the historic bankruptcy case of Enron suggests, when companies encourage excessive expectations or scramble too hard to meet unrealistic forecasts by analysts they often take highly risky valuedestroying bets. In addition, smoothing financial results to satisfy analysts’ demands for quarter-to-quarter predictability frequently requires sacrificing the long-term future of the company. Because the inherent uncertainty in any business cannot be made to disappear, striving to achieve dependable period-to-period growth is a game that CEOs cannot win. Pushing the consequences of the uncertainty inherent in every industry and every company down here today and there tomorrow only causes it to pop up later somewhere else, often with catastrophic results.