Chapter 4. Creation of investors’ expectations – the role of investor relations and company information policy 4.1. Technical and fundamental analysis versus the creation of investors’ expectations The multiplication of the invested capital is investors’ fundamental goal. They can achieve it, if they learn or develop themselves methods that would enable them to forecast changes on financial markets as accurately as possible. One of the most common elements of modelling expectations is referring to historical data. They are usually interpreted via technical analysis, which aims at forecasting future price trends on the basis of past market activity. The technical analysis model assumes that prices of securities change according to repeatable, observable cycles, which create geometric shapes when represented in charts. Technical analysts believe that investors’ expectations precede economic phenomena, and base their analyses on the following assumptions (Zaleśkiewicz 2011: 293): 1. The market value of stock is determined by demand-supply relation. 2. The market rate of stock depends on both rational and irrational factors (e.g. they can be influenced by changes in investors’ mood). 3. Stock prices form trends. 4. Changes in trends are caused by changes in demand-supply relation. 5. Patterns of changes are repeatable, which makes them possible to predict. 6. Changes in supply-demand relation can be observed on charts representing price changes. 7. Analyses are based on a long-term trend on which local trends of a lower order are superimposed. It means that for instance local downward trends may appear within a long-term upward trend, or vice versa. 8. Stock price analysis should be inextricably linked to volume analysis. 9. The efficiency of technical analysis should increase with the increase of market liquidity. 10. Investment decisions should be based on the use of several tools within the scope of technical analysis. To forecast future stock prices technical analysis uses various tools, such as trend analysis, cycle analysis, formation analysis, and indicators. In the case of the first of the listed tools, the identification and tracking of trends should help to maintain investment approach in line with the direction of the trend. According to technical analysis, investors’ positive expectations will inspire uptrends, negative moods will result in downtrends, and a horizontal trend will reflect volatile or neutral expectations of traders (Zielonka 2011: 20-21). Trend lines indicate the direction and pace of price movements by linking pivot points within a particular trend. An uptrend is indicated by a series of increasingly high highs which can be connected by a straight line. Likewise, a downward trend line is formed by a series of lows, each one lower than the one before (see Fig. 4.1). The best-known tools used in trend analysis are Dow Theory and Elliott wave principle. Dow Theory was based on an analysis of stock market index movements, which reflected the industrial average (comprised of industrial companies’ stocks prices) and the transportation average (comprised of transportation companies’ stock prices) (Zielonka 2011: 21). Charles Dow discerned three types of price trends: the main movement – a major trend lasting from several to several dozen years, the medium swing – a secondary trend lasting from several weeks to several years, and the short swing – a minor trend lasting only a few days. In addition, a trend consists of three phases: (1) an accumulation phase when knowledgeable investors accumulate shares, (2) a public participation (or absorption) phase when traders are joined by technical analysts and other trend followers, and (3) a distribution phase, in which knowledgeable investors start to sell shares. Dow Theory also asserts that a trend will continue when industrial and transportation averages move in the same direction. Elliott wave principle was created in the 1930s by Ralph Nelson Elliott who discovered that stock prices can be represented by downward and upward wave patterns. At the same time, the underlying assumption of this theory is the fact that fundamental factors have no bearing on price charts, because the market consists of people and their emotions. Therefore, what affects the shape of stock price charts is not the information itself, but the importance ascribed to it by investors. It follows that the principle yields better results on markets with a large group of investors, but its prognostic value is not always the same. Technical analysts notice that stock price charts create many repeatable patterns called formations. They are identified by combined price and volume movements, as well as price changes in relation to support and resistance trend lines (Sopoćko 2003). A support line marks the lowest lows of stock prices (the level which lows reach, but do not fall below), while a resistance line indicates the highest stock prices. If it is possible to draw both support and resistance lines, and they are approximately parallel, we can say that the price of stocks moves in a trend channel (see Fig. 4.2). In technical analysis it is possible to forecast price movements also through indicators, which generate buy or sell signals for the analysed stocks. Table 4.1 compiles the most popular and commonly used technical analysis indicators (see Tab. 4.1). Technical analysis is often described as a very simplified psychological analysis of the market, mainly because it is possible to predict a company’s stock prices without any knowledge about it or the market on which it operates. Essentially, technical analysis combines statistical and psychological factors. Due to the latter ones, forecasts derived from technical analysis somewhat resemble self-fulfilling prophecies (Akert et al. 2008, quoted in Zaleśkiewicz 2011: 295-296). It means that if investors expect that using technical analysis will help them obtain superior returns, their decisions based on signals indicated by the analysis prompts the movement of stock prices in the expected direction. Moreover, taking into account the psychological dimension of decision-making on the financial market points to the fact that investors who use technical analysis often discern trends or formations in completely random price patterns (Cootner 1964). An explanation of this phenomenon might be found in research carried out by J. Zweig (2007) who asserts that human brain does not tolerate uncertainty or ambiguity, so it attempts to order and categorise information it receives. Furthermore, research in neuroeconomics clearly demonstrates the link between past and current investment decisions. Namely, if in the past an investor made a decision based on a particular technical analysis indicator and it turned out to be fruitful, then they will feel strongly motivated to make the same decision when they observe a similar indicator in future. Fundamental analysis is another method used to forecast price movements on financial markets, although it is based on an entirely different philosophy. It essentially involves an attempt to estimate a company’s intrinsic value and compare it to its market value in order to identify undervalued and overvalued stock. Of course determination of a company’s intrinsic value is highly complicated. Hence the thorough process: from the macroeconomic analysis which appraises condition of the entire economy to industry analysis which involves evaluation of certain sectors against others to an analysis of a particular company – both its financial condition and non-financial aspects of the business activity, such as management’s quality and commitment, human capital, or development strategy compared to others in the industry. If the estimated intrinsic value of stocks is greater than their market value, we can suppose that at a given moment investors do not appreciate a company’s securities, but when they notice its potential, the stock price will go up. For fundamental analysts such a situation is a buy signal. In the opposite case, when shares’ intrinsic price is lower than their market price, it can be concluded that the market is too optimistic in its valuation of that company’s stocks, which constitutes a sell signal, since one can expect the market value of stock to drop. The issues outlined above lead to a conclusion that fundamental analysis is based on much more rational premises than technical analysis, which does not imply, however, that it entirely excludes influence of psychological factors on its outcome. Even valuation of a particular company’s stocks itself is very subjective matter, which means that its findings are to a certain degree distorted by an investor’s emotions and cognitive abilities (Zaleśkiewicz 2011: 299). Psychological factors are especially prominent in the case of initial public offerings, when a company only begins to create its stock market history. Obviously, for IPOs fundamental analysis is the only possibility and its results are reflected in traders’ expectations about profitability and investment risk. Research conducted by D. G. MacGregor, P. Slovic, M. Berry and H. R. Evensky reveals however that in the case of little known enterprises – for instance IPOs – about which investors do not know much, general impressions and emotional assessments may be the main criteria for making investment decisions (MacGregor at al. 1999: 68-86). 4.2. The history of regulating information base on stock exchanges as a reaction to crises A new architecture of the global economy and previously mentioned shifts on the capital market, such as the increase of market depth and the stocks’ role among global financial assets, dynamic development of shareholding, and foreign traders’ growing participation in stock investments increase the significance of investor relations. IR is important not only as a tool for creating a company’s success on the capital market, but also as a crucial element which strengthens international financial system through transparency and corporate governance (CG) standards (Cf. Weltke 2002). Today, over 80 million investors participate in [the U.S. capital] markets, providing over 15,000 companies a source of capital, and generating approximately $16 trillion in wealth for investors. And this success in in no small part due to the trust and confidence the investing public place in the financial information they receive and analyse (Rieves and Lefebvere 2012: 73). We should keep in mind that bull market and bear market have one fundamental thing in common: they are both markets. So, regardless of their structure and size, on both markets expectations are formed, shares are bought and sold, and companies must compete for capital with hundreds others. A company can boast success if it manages to gain traders’ trust and consequently attract necessary capital. Such success depends on an open, honest, truthful and convincing presentation of those company’s features which can unequivocally confirm that traders were right to invest in it (Rieves and Lefebvere 2012: 13). In addition, one should not expect that a company’s results will speak for themselves. It is true that sometimes, albeit rarely, superior results of a company are discovered and rewarded by the market. But more often credible market valuation requires planned communication efforts on the part of a company. Moreover, there exists at least one reason why a company should actively engage in a dialogue with the investor community; a reason which lies in the very nature of the securities’ analysis process. Nowadays overwhelming majority of analyses is based on a company’s intangible value drivers, such as management’s competences and commitment, a firm’s ability to plan and achieve goals, etc. The clearer and more precisely a company defines intangible sources of value, the better traders will understand its ability to increase invested capital. The greater faith and trust in a company, the lower the investment risk and the capital acquisition cost, and the bigger competitiveness of a company on the capital market (Rieves and Lefebvere 2012: 15). Therefore the problem of investor relations and companies’ readiness to share information as a fundamental factor influencing investors’ expectations and stock prices on the capital market becomes particularly significant, mainly in terms of gaining, maintaining and regaining investors’ trust. The 2007-2009 financial crisis undoubtedly left its mark on investors’ confidence in the capital market and its basic institution – the stock exchange. We should bear in mind that the analysis of investor behaviours and the situation on the stock exchange are treated as a barometer reflecting the state of the entire economy. Trust is therefore indispensable for the financial system’s stability. It is also obviously much easier to shake confidence in the stock exchange and other financial institutions during a market slump. Individual investors’ rational behaviour often morphs into collective irrationality with unpredictable economic, social and also political consequences (Hucik-Guicka 2006: 1). Undoubtedly such investors’ behaviour is influenced by rating agencies. Traders believe that ratings issued by agencies reduce risk and increase rationality of their behaviour. But as it has been explained in chapter 3, it means that ratings contribute to the creation of so-called self-fulfilling prophecies. Particular investors’ focus on opinions and evaluations made by various institutions stems also from unequal access to information, which motivates them to follow the example of other, better informed market players (Hucik-Guicka 2006: 1). Thus a vicious circle of crisis is created (see Fig. 4.3). Owing to the current situation of the banking industry, the entire saving and investment process is perceived in an increasingly negative way. Considering how often the loss of confidence in the whole financial system is mentioned, the only way out of this situation is to rebuilt trust in global financial markets, especially capital markets and public companies. One of the trust-building elements, which coincidentally is also an important factor affecting the creation of investors’ expectations is undoubtedly efficient corporate governance (Cż), defined as “mechanisms by which a business enterprise […] is directed and controlled” (Report of the committee on the financial aspects of corporate governance 1992). The Organisation for Economic Co-operation and Development (OECD) defines corporate governance as “a set of relationships between a company’s management, its board, its shareholders and other stakeholders” that also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined (OECD 1999, 2004). CG is one of the key elements of stock company management. It should ensure that its goals are executed according to shareholders’ interests (Gajewska-Jedwabny and Jedwabny 2007: 24), which in turn increases a company’s value and its competitiveness in the capital market. Therefore in the narrowest sense, corporate governance serves to ensure that actions undertaken by executives are in keeping with shareholders’ interests. In a broader sense, efficient corporate governance helps to ensure that a company’s strategy and executives’ actions are aligned with expectations and needs of the vast group of stakeholders. Since the publication of A. Rappaport’s Creating Shareholder Value in 1986, we can observe growing interest in Cż. The author asserts that the principal goal of a company’s business activity is creating shareholder value and corporate governance is a condition necessary to fulfil it. Impact of CG on the control over shareholder value creation can be considered in the following aspects1: • • legitimisation of value growth as a fundamental goal of a limited company’s business activity; accountability of the supervisory board and the management board to shareholders – properly working supervisory bodies should contribute to the execution of • company strategy in accordance with shareholders’ interest; company data transparency – reliable information is the fundamental tool which guarantees shareholders’ control over the management board and Cż should guarantee equal access to such information to all shareholders. However, an attempt to quantify the influence of actions aimed at “improving” corporate governance on increasing company value presents certain difficulties. But research conducted by McKinsey&Company indicates that effective and transparent management is at least as important for the creation of investors’ expectations as a company’s performance (Gajewska-Jedwabny 2004: 487-488). It turns out that almost 30% of the respondents have never invested in countries which did not adopt efficient CG mechanisms, and over 70% of investors were prepared to pay premiums for stocks of companies which abided by CG rules. The premium amounted to 11-41%, depending on the region and geo-political stability of a country. Financial crises of the 20th century have played a considerable role in the rise of corporate governance importance. They have exerted major impact on systemic regulations concerning the quality of information released on capital markets, which is then used by traders. First attempts to regulate information emerged in the wake of the Great Depression 1929-1933, when the stock exchange as well as the accounting and auditing circles were 1 Cf. Gajewska-Jedwabny and Jedwabny 2007: 24-25. subject to severe criticism. A thorough analysis of the sources of the crisis revealed that one of the major causes was lack of reliable and complete information, which shareholders and potential investors could use to make investment decisions and form expectations about the future rate of return. In the aftermath of the stock market crash of 1929 the Securities Act (1933) was enacted. It included requirements concerning information disclosure and accounting which had to be met by companies that wanted to register their securities for trading on the stock exchange (Kutera and Surdykowska 2009: 21-23). In 1934, the Act was amended, which prompted the creation of the Securities Exchange Commission (SEC), an independent government organisation responsible for enforcing laws relating to securities trading and stock market, and issuing relevant recommendations and regulations concerning financial reporting. The Great Depression revealed the need to create a separate body to draw up rules and regulations for accounting and financial reporting. For this purpose, in 1939, the Committee on Accounting Procedures (CAP) was established. It consisted of chartered accountants and issued bulletins with proposed solutions for problems reported by business circles. In 1959 a new organisation was created: Accounting Principles Board (APB), which was tasked with drawing up an accounting and financial reporting framework. However, due to significant differences between APB and SEC the task has not been accomplished and the organisation was disbanded in 1971. Subsequent steps towards the creation of institutions that would guarantee financial reporting credibility were marked by the 1973 oil crisis, the dissolution of the Soviet Union, and the beginning of a new global order which they entailed (see Tab. 4.2) (Kutera and Surdykowska 2009: 23-24). Strong rise of the Cż’s role was undoubtedly connected to financial scandals which occurred at the turn of the 19th and 20th centuries. The downfall of the energy company Enron and financial scandals involving WorldCom and Tyco rocked capital markets all over the world, and eventually dramatically undermined the credibility of information disclosed by companies and their management. The crisis of confidence triggered a range of initiatives to create and develop rules of corporate governance. Furthermore, globalisation of capital markets enhanced efforts of institutional investors, international organisations and companies operating on the global market to unify CG regulations, which differed slightly in each country. As early as May 1999, the OECD Ministerial Council launched OECD Principles of Corporate Governance, a document containing a list of recommended – although not obligatory – good practices in corporate governance, which constitute a point of reference in the assessment and improvement of CG rules in each particular country (Kutera and Surdykowska 2009: 488). Corporate governance regulations in companies vary in each country due to deeper cultural connotations, as well as historical and social conditions in which a particular model of economy (particularly the capital market model) developed. Generally speaking, in developed countries two major models of the capital market can be distinguished: the Anglo-American and continental/Japanese model (Cf. Campbell and Jerzemowska 1998) and each is markedly different when it comes history, political values and ideology. Certain authors prefer a more detailed division into the Anglo-Saxon (USA, UK), the European (continental Europe) and the Asian model (Japan)2. The United States, a country with the best developed market economy in the world, has a well-established shareholding culture and extensive legislation in order to ensure capital markets’ liquidity and flexibility, and protect shareholders. Moreover, as institutional investors gather more and more stock and their power becomes concentrated, they also become active proponents of corporate governance. For instance, California Public źmployee’s Retirement System (CalPźRS) together with two other retirement funds established the Council of Institutional Investors (CII) in order to propagate changes in capital market regulations. Robert Ż. Carlson, one of CalPźRS’ leading managers, stated that “pension funds are now filling a void in which the management of public corporations had become autonomous and, in extreme cases, unaccountable to the very share owners of the corporations paying their salaries” (Black et al. 1997). Shareholders’ insistence on the improvement of CG standards is becoming an increasingly important part of the investment landscape. After the wave of scandals and bankruptcies on the American capital market it became clear that formal regulation of corporate governance is essential. In July 2002, the Congress 2 Some economists point to varying approaches to a limited company in the Triad countries: USA, UK, Europe and Japan. It is possible to distinguish three concepts (See Je ak 2002: 82): 1. 2. 3. Monistic, which stresses that enterprise as private property should be oriented on accomplishing its shareholders’ interests. This is a dominant approach in the USA, the UK, Australia and New Zealand. Dualistic, which puts emphasise on shareholders’ interests, but also takes into account interests of the employees. It is the dominant approach in Germany and other continental European countries. Pluralistic, in which the enterprise belongs to all interest groups, namely: employees, shareholders, the main creditor, main co-operators, suppliers and distributors, however the employees’ interest in the most important. This approach is most common in Japan. passed the Sarbanes–Oxley Act, which comprised of eleven sections containing detailed regulations concerning corporate governance areas and a company’s communication with shareholders (Gajewska-Jedwabny 2004: 491). Particular emphasis was put on the possible occurrence of conflicts of interest, necessity to implement complex solutions in the area of internal control, issue of independent external audits as well as accountability and competency of a company’s governing bodies. Particular efforts to develop corporate governance rules were made in the UK. Four reports – Cadbury, Greenbury, Hampel and Higgs – containing recommendations for CG rules proved to be especially successful in this endeavour. The Cadbury report from 1992 entitled The Financial Aspects of Corporate Governance specified recommendations for corporate governance in companies and divided them into three areas: 1. Board of directors’ structure and accountability – recommendations with regard to regular meetings, effective supervision of the management, clear division of responsibilities within the board, the need to employ non-executive directors, entitling all members of the board to take independent professional advice at the company’s expense , securing the board of directors’ influence on decisions regarding their company’s future progress and control; 2. Independent auditors – recommendations with regard to the necessity to review interim reports, full disclosure of fees paid to auditors for non-audit work, reports on the effectiveness of the internal control system; 3. Shareholders’ rights and responsibilities – recommendations with regard to the possibility of representation by specialised investor organisations, creating conditions in which all shareholders can ask questions, comment financial results and management’s activity during general meetings, participation of institutional investors in communication with executives in order to exchange views on strategy and other information, disclosing and ensuring equal access to information, or preventing the exploitation of confidential information. The Greenbury report from 1995 focused on the question of establishing and disclosing managers’ remuneration, and its recommendations included, among others, full disclosure of all board members’ remunerations from at least three previous years, appointment of an internal remuneration committee which would draw up and monitor executive pay policies (Gajewska-Jedwabny 2004: 494). The Hempel report from 1998 was designed as a summary of recommendations from the two previously described reports. It featured the Combined Code – a code of good practices that included 14 rules of corporate governance and 45 detailed regulations with which companies listed on the London Stock Exchange had to comply. Moreover, the companies were required to report on the implementation of each of the code’s rules in their annual statement (Corporate Governance In Europe, KPMG Survey 2001/1002). Review of the Role and Effectiveness of Non-executive Directors, or the so-called Higgs Review, which amended the Combined Code, was published in 2002. A. GajewskaJedwabny (2004: 496) points out that the participation of all market agents in the creation of corporate governance rules allows for an effective cooperation of all interested parties, as well as universal acceptance and relatively fast implementation of recommendations. In Europe (with the exception of the UK), capital markets are considerably smaller than in the USA. Participation of the general population in the shareholding is also significantly lower which is due, among others, to the fact that the shift from state-funded towards privately funded retirement systems is still minor. Besides, in Europe the attraction of capital cannot overcome the historically strong and still prevailing popularity of government treasury bonds, and external financing of companies is dominated by loans from institutional, not market sources. Nevertheless, the European Union invests considerable effort in the promotion of CG. In 2002, the EU adopted a decree on the application of IAS/IFRS. In May 2003, the European Commission presented a long-term action plan entitled Modernising Company Law and Enhancing Corporate Governance in the EU. The issued perceived at the time as the most important and urgent included3: • • introduction of a descriptive statement covering corporate governance practices into a company’s annual report, creation of the European Corporate Governance Forum in order to support coordination and convergence of national codes, their implementation and • monitoring, • rights, introduction of regulations which enable or facilitate execution of shareholders’ recommendations concerning directors’ remuneration, which guarantee more transparency and influence on remuneration policy for shareholders. 3 European Commission Launches Corporate Governance Action Plan, http: //www.ecgi.org Other regulations concerning the creation of corporate governance included in the EU legislation are (Kutera and Surdykowska 2009): • • • April 2003 – third consultative document of BCBS; 2003 – IAS 32 divided into two standards: IAS 32 Financial Instruments: Presentation and IAS 7 Financial Instruments: Disclosure; 2004 – the final version of Basel II introduced a new category of risk: operational risk, and methods to measure it in banks’ capital adequacy assessment (previously, • • • • • • • two types of risk were taken into account: market and credit risk); 2004 – IAS39 Financial Instruments: Recognition and Measurement modified; 2004 – IAS 38 Intangible assets changed; 2005 – IAS 39 amended; 2005 – listed companies in the EU obliged to adhere to IAS/MSSF; 1 January 2007 – Basel II comes into effect; Directive on the exercise of certain rights of shareholders in listed companies (2007/36/EC); EU Directive on related party transactions (78/660/EC), directive on takeover bids • (2004/25/EC); • codes in Member States (2006/46/WE); EU Directive supporting the implementation of national corporate governance European Commission Recommendation of 30 April 2009 complementing Recommendations 2004/913/EC and 2005/162/EC as regards the regime for the • remuneration of directors of listed companies (2009/385/WE); European Commission Recommendation of 14 December 2004 fostering an appropriate regime for the remuneration of directors of listed companies • (2004/913/WE); Green Paper on corporate governance in financial institutions and report on remuneration (2009/384/EC). In Poland, the initiative to draw up rules of corporate governance for companies listed on the WSE and to create a Corporate Governance Forum emerged in autumn 1998. Dynamic development of the capital market, which reflects Poland’s strong entry into the global circulation of capital, popularised the idea of corporate governance. The investor community itself pushed for the creation of better CG regulations. Traders asserted that efficient corporate governance system should help to limit instances of abuse of power and infringements of minority shareholders’ rights, as well as increase the quality of management, and consequently lead to the increase in a company’s stock prices. The main documents concerning CG were: • • • Corporate Governance Code prepared by the Institute for Market Economics within the scope of activities of the Polish Corporate Governance Forum. Best Practices in Public Companies 2005 – a document prepared by the Best Practices Committee of the Polish Corporate Governance Forum.4 Best Practices of WSE Listed Companies – the document came into effect on 1 January 2008. The current version of the latter document came into force on 1 January 2012. The objective of Best Practices of WSE Listed Companies is to strengthen transparency of listed companies, improve the quality of communication with the investor community and strengthen the protection of investors’ rights. The following regulations refer directly to investor communication: I. 1. A company should pursue a transparent and effective information policy using both traditional methods and modern technologies and latest communication tools ensuring fast, secure and effective access to information. Using such methods to the broadest extent possible, a company should in particular: - maintain a company website whose scope and method of presentation should be based on the model investor relations service available at http://naszmodel.gpw.pl/; - ensure adequate communication with investors and analysts, and use to this purpose also modern methods such as on-line communication; - enable on-line broadcasts of General Meetings over the Internet, record General Meetings, and publish the recordings on the company website. II.1. A company should operate a corporate website and publish on it, in addition to information required by legal regulations: 4 This document was issued in October 2004. Before that relevant regulations were specified in Best Practices in Public Companies 2002. 1) basic corporate regulations, in particular the statutes and internal regulations of its governing bodies; 2) professional CVs of the members of its governing bodies; 3) current and periodic reports; 5) where members of the company’s governing body are elected by the żeneral Meeting – the basis for proposed candidates for the company’s Management Board and Supervisory Board available to the company, together with the professional CVs of the candidates within a timeframe enabling a review of the documents and an informed decision on a resolution; 6) annual reports on the activity of the Supervisory Board taking account of the work of its committees together with the evaluation of the internal control system and the significant risk management system submitted by the Supervisory Board; 7) shareholders’ questions on issues on the agenda submitted before and during a General Meeting together with answers to those questions; 8) information about the reasons for cancellation of a General Meeting, change of its date or agenda together with a justification; 9) information about breaks in a General Meetings and the grounds of those breaks; 10) information on corporate events such as the dividend payout, or other events leading to the acquisition or limitation of rights of a shareholder, including the deadlines and principles of such operations. Such information should be published within a timeframe enabling investors to make investment decisions; 11) information known to the Management Board based on a statement by a member of the Supervisory Board on any relationship of a member of the Supervisory Board with a shareholder who holds shares representing not less than 5% of all votes at the company’s żeneral Meeting; 12) where the company has introduced an employee incentive scheme based on shares or similar instruments – information about the projected cost to be incurred by the company upon its introduction; 13) a statement on compliance with the corporate governance rules contained in the last published annual report, as well as the report referred to in § 29.5 of the Exchange Rules, if published; 14) information about the company’s internal rules of changing the company authorised to audit financial statements or information about the absence of such rules. II.2. A company should ensure that its website is also available in English, at least to the extent described in section II.1. IV. 1. Media representatives should be allowed to observe General Meetings. 10. A company should enable its shareholders to participate in a General Meeting using electronic communication means through: 1) real-life broadcast of General Meetings; 2) real-time bilateral communication where shareholders may take the floor during a General Meeting from a location other than the General Meeting; 3) exercise their right to vote during a General Meeting either in person or through a plenipotentiary. (This rule should be applied not later than 1 January 2013). Certainly, corporate governance rules helped to increase the transparency of listed companies’ operations, which is of paramount importance for investors’ expectations creation and the effectiveness of the capital market. But it is still necessary to develop CG and add to it new solutions, taking into account the broad perspective of companies’ disclosure duties and their accountability to all shareholders. Moreover, the comply or explain rule generates an additional set of issues. Does the requirement to present a report on compliance or noncompliance with CG rules ensure high quality of corporate governance? Perhaps obligatory compliance with all code regulations would guarantee more certainty? But on the other hand, what if more requirements imposed on companies discourage them from entering the stock market, and thus slow down the capital market development? All these questions provoke a lively debate among theoreticians and practitioners of corporate governance alike. 4.3. Corporate governance crisis 2001-2009 what’s next? The 2007-2009 financial crisis revealed weak spots of corporate governance systems. They can be found in four major areas (Wolpert 2009): 1. managers’ remuneration process, 2. board practices, 3. risk management, 4. shareholder (in)activism. In the US, the considerable increase in the ratio of managers’ to average employee pay, which began in the 1990s, is clearly visible (see Fig.4.4). But a similar upward trend in executive pay could be observed also in other countries. But why did this process accelerate so much in the 1990s? Certainly, this decade saw the increasing popularity of remuneration schemes in which managers’ salaries were conditional on the increase in a company’s market value. The idea of “rewarding for profits” was universally supported by shareholders, but with time the criteria on which executives’ premiums were calculated became less and less clear. Moreover, the link between these premiums and actual managers’ results, measured e.g. as the market price of stocks, was often very weak. Furthermore, the construction of option-based remuneration programmes brought the managers profit in a relatively short time, which increased their tendency to take bigger risk. Without the proper consideration of risk, managers’ remuneration schemes diverged from investors’ benefits. It also meant that managers were “overpaid”, i.e. rewarded disproportionately to their input in value creation. The crisis has exposed the urgent need to introduce changes in the structure of executive remuneration packages. In this respect, major challenges are: strengthening the link between investors’ and managers’ risk, improving the transparency of remuneration schemes and disclosure of information concerning managers’ salaries and their foundations.5 From the vantage point of shareholders and potential investors, competences and functioning of supervisory boards are undoubtedly of paramount importance. Financial crisis and the economic stagnation in 2008-2009 inspired debate around the extent of supervisory boards’ accountability and possibly presented them with new challenges. Because on the one hand fears of investors and other stakeholders concerning boards’ activity, efficiency and effectiveness have significantly increased. On the other hand, in the current situation, when companies face more and more serious risks which may hinder their development or even endanger their future, there exists a pressing need to monitor and supervise management boards. The crisis has exposed the weakness of risk oversight, especially poor risk management systems and lack of transparency in this area. Difficulties were due especially to the lack of competent boards capable of objective and independent judgement, the fact that 5 Żurther discussion of managers’ remuneration can be found in chapter 5. the function of CEO and the chair of the board of directors were not always separate, and weak shareholders’ involvement in the appointment of supervisory board members (OźCD 2009: 9-10). The analysis of supervisory boards’ activity in companies listed on the WSź conducted on the eve of the crisis in 2007 revealed that boards themselves gave high marks to their efforts in the area of monitoring and assessment of business and operational risks (Deloitte 2007) as well as risk management. We should, however, stress that as much as 25% of supervisory boards did not consider risk monitoring as their duty, and only 46% of companies have specified risk management rules and evaluated their efficiency regularly. Only Poland was an exception in this respect. The Committee of Sponsoring Organizations of the Treadway Commission (COSO, http://www.coso.org) indicates that the financial crisis has produced three major changes in the oversight of risk management system6. Firstly, the New York Stock Exchange now requires audit committees of listed companies to analyse the process of risk identification and assessment, and relevant procedures. Secondly, credit rating agencies (e.g. S&P) are now assessing enterprise risk management processes as part of their rating process. Thirdly, more and more voices (SEC Chairman Mary Schapiro among them) propose that supervisory boards should be charged with the responsibility to oversee risk management, a duty similar to their responsibility for the financial reporting process. Risk management oversight requires more awareness and effective implementation of risk management policies, the improvement of reporting on risk management process and practices, as well as the integration with the internal control system. It seems essential to understand that risk management is not just a matter of measurement, but above all a matter of quality of decisions that companies take under uncertainty conditions. In a sense, investors – especially institutional investors – are responsible for the crisis. Their blame lies in the passive approach and lack of involvement in companies’ internal management process. In this respect, the authors of the OECD report Corporate Governance and the Financial Crisis from June 2009 listed the following major causes of the CG crisis: (1) The alignment of shareholders’ and executives’ interests was not sustained and it “was associated with a great deal of short-term behaviour”. (2) Shareholders, especially institutional investors, tended to be reactive (low voting participation). (3) Companies did little to support constructive relations with their shareholders. We can recapitulate these findings by saying that shareholders did not take on the responsibility to become proactive 6 http: //www.coso.org/documents/COSOBoardsERM4pager-FINALRELEASEVERSION82409.pdf and cooperate with companies’ management in order to ensure the credibility of business plans. Lacking were also proper structures of supervisory boards and their effectiveness. Does it not prove that, in a sense, the crisis has demonstrated where capitalism without properly involved and responsible shareholders may lead? Proposed solutions for eliminating existing sources of corporate governance dysfunctions are presented in table 4.3. Even though the majority of researchers in the field of corporate governance focus on issues related to ownership structure or supervisory bodies, what becomes increasingly important is initiatives aiming to increase the disclosure of information about companies and improve investors’ and other stakeholders’ access to this data. They are after all the foundation on which expectations are created. A company’s openness with information is therefore a test for a company’s supervisory bodies and their accountability to shareholders and other stakeholders. It is also an essential element in the creation of investors’ expectations and in the process of long-term value creation. 4.4. Investor’s information expectations The traditional model of companies’ information policy and investor relations relies to a large extent upon the publication of historical financial data. In the current economic conditions, following shifts in companies, the investor community and business circles in general, and on the capital market in particular, this traditional model does not endure the test of time and fails to fulfil its function effectively (Gajewska-Jedwabny 2004: 454). Several causes of such inefficiency can be discerned. Firstly, financial scandals that occurred at the turn of the 19th and 20th centuries rocked capital markets and dramatically undermined the credibility of and trust in companies and their management. It turned out that the existing financial reporting system has given free hand to the development of the so-called creative accounting and various malpractices in the area of regulation interpretation. As a result, investors started to demand thorough changes in companies’ current information policies and pushed for more openness with information that would minimise the possibility of similar events occurring in future. Business theoreticians and practitioners alike engaged in a lively debate in order to redefine the model of financial reporting for companies so as to include a more open approach to disclosing information. Żrom the objective point of view, it is absolutely critical in the times of crisis of investors’ trust in companies (Marcinkowska 2004b: 8). It is also indispensable for rebuilding firms’ credibility in the eyes of owners and other stakeholder groups. Secondly, shareholders’ growing awareness, institutional investors’ rising importance, and danger of hostile takeovers marked the beginning and influenced the development of investor capitalism (described also as shareholder value capitalism, shareholder revolution, or shareholder value culture). We have already mentioned the exponential growth of capital markets, expansion of private equity, and professionalisation of investment processes which is related to the development of institutional shareholding. Institutional investors constantly increase their demands with regard to information delivered by companies to capital markets. Above all, they expect reliable information about a company’s current strategy and development prospects which they could use to make rational decisions about capital investment in a particular enterprise. Thirdly, the influence of intangible assets on companies’ financial situation and development prospects, which began in the last century, becomes more and more prominent. Changes in companies induced by the fast-paced progress in IT and new technologies as well as social processes emphasised a new tendency: a company’s market performance is no longer determined by material assets, but rather by soft values, hidden assets, such as: qualified employees, innovation, brand, reputation, quality of strategy, organisational culture, etc., or in other words – intangible assets. Companies’ financial results are in fact a result of their past actions and past events, whereas intangible assets are decisive for a company’s future performance. Due to the increasing importance of intangibles, the assessment of a company’s attractiveness and the process of creating expectations about its results is no longer based exclusively on the analysis of its financial situation. Intangible assets – defined as a firm’s intellectual capital (or knowledge capital, knowledge assets) (Dudycz 2005: 212-214) – can increase a company’s profitability, enable the creation of new products, services and economic processes, establish new forms of organisation, and enhance performance. It follows that they have potential for value creation. Even the identification and communication of intangible value may considerably influence the creation of investors’ expectations, and consequently the market valuation of a company (Read et al. 2001). But most intangibles still escape the traditional financial reporting. What follows is a significant discrepancy between information included in financial reports and a company’s valuation on the capital market. Hence an extremely pressing need to increase the scope of information disclosure, especially in order to include contemporary sources of a company’s value.7 Żourthly, the growing pressure to make companies’ more open with information results from the scale of information democratisation in the current world (Remisiewicz 2006: 579). Thanks to the dynamic IT development the amount of information available to investors grew considerably. Now they have access not only to fast information networks, but also to specialised software for all kinds of analyses. There also exist databases which enable them to receive up-to-date information and news from financial markets all over the world via the Internet.8 Instant communication with the market has become easier and unencumbered by costs (Dembiński 2002: 19). The expansion of the Internet turned the 21st century into the age of creating networks that “will enfold the earth in a communications skin resembling the human nervous system" (Netravali 2000). All these changes on the one hand make it easier for companies to engage in open communication with the investor community and other agents, but on the other hand – face them with increasingly greater challenges. The emergence of the market cyberspace forces companies to respond to investors’ heightened information expectations. In addition, there arises a need to bring order to information chaos and provide the environment with reliable, credible information which would create a cohesive and truthful image of a company and its development prospects in the volatile environment. Information that is reliable, honest and tailored to users’ needs is highly valuable, and that value is determined by its potential use in analyses (Tokaj-Krzewska 2006: 198). For this purpose companies can use the eXtensible Business Reporting Language (XBRL) which unifies the reporting format and information. It has already been mentioned that an increasing number of economies is rapidly transitioning from industrial to information society. As a result, the possibility to build sustainable competitive advantage and create value is determined by intangible assets and intellectual capital resources which are difficult to measure (Marcinkowska 2004b). Therefore, the traditional reporting model must evolve towards more open access to information concerning intangible value sources. Companies themselves notice investors’ growing information expectations. A study of a purposive sample of individual investors, stock market analysts and listed companies from June 2009 through March 2010 clearly indicate that companies are becoming more and more 7 Suggestions as to how reporting should be expanded will be presented in section 4.6. 8 The most popular are: Bloomberg, Reuters, Bridge Information System, CompuServe Inc., and Quick Quote. aware of investors’ demands concerning IR and corporate information policies (Dziawgo 2011: 221-285) (see Fig. 4.5). Dziawgo’s study based on Observation of companies reveals that investors expect (Dziawgo 2011): • • more transparency; • data concerning future prospects; • quick feedback; • full information on the corporate website; • full access to clear financial data; • community; • more direct contacts with a company; • meetings and on-going contact with a company; • fast access to information, preferably in digital form; • more data and information; • clear indication of the factors that determine a company’s future; diversification of communication channels used to engage with the investor • the increase of information quality and accountability for disclosed information; • performance forecasts for the next 3 years; • entire environment, and of financial results; • more frequent explanations of events in a company, its capital group, and the more intensive use of Internet and modern communication technology; forging investor relations into a company’s success driver and value growth generator. The same study clearly indicated soaring information expectations of individual investors, who would like to receive more information concerning (Dziawgo 2011: 259): • • companies’ long-term plans and prognoses; • faster publication of results; • analysis of sales and the industry; • • risk management system; company’s market situation; comparison with the competition; • • accomplished plans and gained profits; • long-term company strategy; • value management metrics: EVA and MVA; • detailed investment plans; • changes in investment plans and financial liquidity; detailed reports on negative events, explaining their causes and potential consequences. Stock market analysts, too, frequently signal the demand for information concerning prognoses, companies’ strategic goals, detailed geographic and segment sales and profitability, or detailed data which directly influences financial results (Dziawgo 2011). It is noteworthy that although for individual investors IR quality is not a decisive factor in making a decision to invest in a particular company, almost 70% admit that investor relations substantially influence their expectations and investment decisions. 50% of investors believe that bad IR quality is a reason to withdraw their investment or at least consider such a decision (Dziawgo 2011: 247-248). We can therefore conclude that companies have considerable potential for the purposeful creation of investors’ expectations. The more so, since both investors and analysts are prepared to pay premiums for a company’s transparency. The premium can amount to 10 to 80% in the case of traders, and 5 to 20% for stock market analysts. (Dziawgo 2011: 249-251). 4.5. Gaps in the communication system between companies and the investor community Information policies of listed companies are deeply set in current regulations and the traditional model of investor relations that comprises of fulfilling the information duty imposed by law, which entails publishing information about past events with considerable delay and disclosing financial data which has no direct bearing on value creation and do not include sufficient amount of nonfinancial information (GajewskaJedwabny 2004: 459-461). We can therefore signal an urgent need for change, or rather complete restructuring in the area of IR, information policies and corporate reporting. In this respect, researchers evoke another aspect of the information disclosure, namely voluntary disclosure. To the company that recognises that it must compete for capital over the long run, the problem of disclosure should be viewed not only as one of regulation, but as the opportunity to display every aspect of the company that can contribute to a rounded picture for the prospective investor or lender (Marcus 2005: 50). Related concepts present in the literature include proactive information disclosure and unique selling points, i.e. a company’s unique characteristics (Andrzejewski 2003: 92). These concepts aim at directing focus on the disclosure of information concerning those of a company’s attributes that distinguish it from the competition and allow to display features that are fundamental for a business and constitute the source of its value, for instance exceptional skills, innovation, R&D investments, environmental awareness, etc. In the context of our deliberations and using investor relations for intentional creation of investors’ expectations it is important to quote the results of selected research conducted to verify the quality of the existing model of investor relations as well as the utility and quality of information provided by companies to the capital market. The authors of the paper Corporate Reporting. Is it what investment professionals expect? (PricewaterhouseCoopers 2007b) clearly indicate the significant disparity between investors’ needs for information and the adequacy of information disclosed by companies (Fig. 4.6. Read vertically, the chart indicates the importance of information and the adequacy of information provided in that area. Read horizontally, it shows main areas of managers’ focus.) In this regard, equally interesting are the results of a study carried out by the Polish Institute of Investor Relations, as well as already presented research conducted by Dziawgo. When juxtaposed with previously discussed challenges in the area of information policies, they constitute a starting point for the identification of existing communication gaps, and more importantly for the search for methods and ways to ameliorate companies’ relations with the environment. The image of investor relations that emerges from this research cannot be deemed satisfying, especially from the vantage point of individual investors who clearly point to the existing deficiencies, particularly (Dziawgo 2011: 252-253): • • lack of complete information about a company’s current activities on its website; • progress reports are too vague; • treating IR as an obligation, not as communication with shareholders; • little care for relations with minority investors; ignoring small investors; • concealing negative information; • not enough activity on the part of those responsible for IR in companies; lack of a single competent person responsible for communicating information and lack of orderly information, which makes it difficult to compare companies with the rest on the industry. In addition, it should be highlighted that investors are not content with how information provided by companies is tailored to their needs. 48% of investors deem such information sufficiently useful, 28% answer that it does not meet their needs very well, and 2% claim that companies do not adapt issued information to the needs of the capital market at all (Dziawgo 2011: 253-254) (see Fig. 4.7). Moreover, the centre of gravity with respect to investors’ information expectations noticeably shifts from financial information towards information concerning future development prospects. Studies conducted by PricewaterhouseCoopers show that key factors taken into account by investors who plan to invest in a particular company are not its financial results, but above all transparency, openness with information and the quality of risk management (PricewaterhouseCoopers 2008: 4) (see Tab. 4.4) In Poland, the evaluation of the IR quality takes into account above all: quality of information about the future and strategy, adequacy of received information to investors’ needs, IR competences, and management’s competence and involvement (Dziawgo 2011: 253). Due to the shifting architecture of the global capital market and the resulting changing conditions under which analysis are conducted and investment decisions are made, sources of value are placed in the synergic coexistence of tangible and intangible assets. It follows that in the creation of investors’ expectations and decision making process, apart from the financing structure and a company’s financial situation, increasingly often the following factors are taken into consideration: the economic context of a company’s operations, the nature of the capital market (or markets) where a company’s securities are listed, the nature of the industry/sector as well as the products and services market, the efficiency of the internal IT network, customer satisfaction, and broadly defined intellectual capital. Individual investors more and more often claim that their decision to commit capital in a particular company’s stock is affected by nonfinancial factors, such as the market position, company’s reputation and brand, corporate strategy, executives’ resumes, expansion plans and future investments, the sector and microeconomic environment, opinions about a company on independent web portals, signed contracts, rotations in the governing bodies, financial investor’s interest, ownership, analysts’ comments, the level of trust for a company, psychology, intuition, and sentiment (Dziawgo 2011: 240). The results presented above lead to an obvious conclusion: there exists an urgent need to modify existing corporate models of information policy and reorient them towards meeting information expectations of investors and other stakeholders. It is particularly significant since investors themselves assert that effective information policy is of considerable importance for the creation of their expectations about a company’s performance, and thus it constitutes foundations on which they base their decision to invest capital in particular companies’ stock. They are also prepared to pay premiums for the shares of companies which are more open when it comes to information disclosure9. Financial reporting framework incompatible with investor expectations leads to the creation of communication gaps among the following types can be discerned (Eccles et al. 2001: 130-141) (see Fig. 4.8): • information gap which appears when investors do not receive any information about a value driver that is relevant from their point of view, or when provided information is unsatisfactory and too general in comparison with market expectations. According to analysts, the biggest information gap concerns: market growth, income from new products, competitive environment, market share, intellectual capital, and customer turnover. Investors point in this respect to the success indicator of new products, market growth, retaining employees and customers, new products creation cycle, competitive environment, intellectual • capital, brand capital and direction of strategic actions (Marcinkowska 2004b: 57). Reporting gap which appears when managers deem a particular factor an important generator of value, but decide not to disclose information on this subject. 9 Studies conducted by the Polish Institute of Investor Relations. • Quality gap which appears when managers deem a particular factor an important value driver, but it is not reflected in the internal reporting system. Usually the biggest quality gap concerns the quality of management, market size and growth, • and notions about competitors (Marcinkowska 2004b: 61). Understanding gap which appears when there is a difference between how much importance is attached to particular factors by managers and by target users of the • information. Perception gap which concerns the difference between managers’ activity in reporting measures and the adequacy of information received by investors. Occurrence of communication gaps translates into divergence between information presented in financial statements and a company’s stock valuation on the capital market, and it leads to the creation of the value gap. 4.6. New approach to investor relations 4.6.1. Challenges of the present times Our deliberations so far imply that one of the essential conditions for the purposeful creation of investors’ expectations and consequently long-term value growth and creation of shareholder value is providing the capital market with reliable and credible information concerning the situation and development prospects of a company (Marcinkowska 2004b: 71). It is especially important since a considerable portion of return for shareholders comes from the increase of stock value. Capital market efficiency is in this case conditional on the availability and quality of information about a company (Black et al. 1997: 86), since a company’s willingness to disclose information guarantees faster capital flow. As information processes improve, capital markets become more effective. It follows that decisions made by managers of listed companies are verified by the market faster and more thoroughly, and companies react to changes in investors’ expectations more efficiently. The implementation of value creation strategy will not result in high market valuation on its own, if a company does not communicate it properly. Companies must therefore expand their reporting to include information about factors essential for creating competitive advantage – sources of its value which are not always reflected in financial reports. It is necessary to communicate to investors actions undertaken in order to create and maintain value in a manner that will guarantee their understanding of the adopted strategy and its goals, and consequently reinforce their trust in the company’s management. źrrors in communication, or insufficient information discourage from making long-term investment and can disrupt the process of creating and maintaining value, restrict company’s competitiveness on the capital market and lower its chances to acquire capital. According to Cole (2004: 21), these are investors, current and potential, who determine a company’s value. Moreover, ensuring better understanding of the strategy enables to protect a company from investors’ short-sightedness and prevent violent reactions to positive or negative forecasts (Hutton and Stocken 2006: 36). D. Ferreira and M. Rezende (2006: 23-24) indicate at the same time that voluntary disclosures in the area of corporate strategy have positive effect on value creation, which is a result of more trust placed in the management. The willingness to share information gives investors’ more confidence in a company’s future performance and actions, which in turn makes them more willing to invest their capital in its securities (Ferreira and Smith 2000: 4). There is no doubt that the type and quality of information about a company as well as the way and speed with which it is communicated influence the interest in a company’s stock and the possibility to form expectations included in stock’s market valuation at the level which is the closest to their fundamental value. Therefore, more and more often, companies attempt to go beyond the traditional understanding of investor relations and shape the company’s description as to create shareholders’ and investors’ hopes for future profits, which means they try to turn the company’s description into a benefits scheme for existing and potential investors (Wójtowicz n.d.). Thus companies attempt to build relations based on reliable information which meets expectations of the capital market (Dziawgo and GajewskaJedwabny 2006: 1). We can conclude that the art of IR consists firstly in a clear presentation of benefits, which should motivate investors to commit their capital to a particular company, and secondly in the disclosure of reliable information on the basis of which analysts and financial media will recommend a particular company to investors. It is important to treat investor relations not merely as a communication tactics, but rather as an element of a company’s strategic management, especially in the context of management oriented on broadly defined value creation.10 Strategic approach to investor relations stems above all from the fact that it can hardly be expected that in the current conditions of financial markets’ complexity, global competition, and growing knowledge and 10 Cf. Financial Expectations: Does Investor Relations Affects Stock Prices?, Chemical Market Reporter, October 7, 2002, www.chemicalmarketreporter.com, p. 21. sophistication of investors, a company will achieve high valuation on the capital market by chance. Furthermore, we can venture a hypothesis that a company that does not approach investor relations as a critical and strategic element of management does not act in the best interest of its shareholders (Ryan and Jacobs 2005: 79). A new approach to investor relations is presented in Tab. 4.5. Since the role of investor relations is changing, they cannot remain merely an administrative function. They require a strategic approach and monitoring on the part of CEO and CFO. If we assume that both the company and the management are a product, investor relations constitute the packaging of that product which is delivered to the capital market. At the current development level investor relations in “enlightened” companies have already reached maturity. But significant changes in this area do occur and their causes are manifold. Firstly, the market itself becomes very complicated, so it requires more skill and knowledge. Secondly, competition for capital and for the attention of the capital market has increased tremendously and as a result investor relations acquired both financial and marketing function. B. W. Marcus and S. L. Wallace identify three components of the marketing function of IR (Marcus and Wallace 1997: 16-30): 1. Knowledge about the market – understanding who are the best prospective customers and learning what they expect from companies in which their invest their capital. Here, of course, ‘customers’ mean the broadly defined investor community. The success of investor relations depends to a large degree on the efficiency and immediate reaction to events occurring on the capital market. Even small and medium enterprises have vast shareholder base, consisting of various groups, each of them very dynamic. Investor relations cannot therefore just stay reactive. Understanding the market requires nowadays exceptional activity, mainly due to unlimited resources of knowledge, which can be acquired and included in the process of creating investor relations in a company. The activity of this process is also enhanced by the awareness that adapting yesterday’s information to today’s market is very costly and ineffective. 2. Knowledge about the product – knowing every aspect and every perspective of what a company has to offer to investors. In terms of investor relations it means mostly the creation of expectations based on a promise of future superior return on investment. Such promise is determined by many factors which determine a company’s value: financial situation, quality and credibility of the management, forecasts for the industry/sector and the company itself, long-term plans, etc. Moreover, the knowledge about a company should be gathered from the vantage point of investors and the capital market so to speak, so it should concur with the investor community’s perception of a company. 3. Knowledge of the tools that can be used to craft effective investor relations in a company, and management of such tools, which means using them to carry out value creation strategy and achieve investors’ goals. źffective competition for the capital requires in this respect the promotion of higher quality standards when it comes to the information companies disclose. Possible solutions include the introduction of reporting formats that are better adjusted to users’ needs, press releases which contain more information, and the improvement of communication skills. Another aspect extremely important for IR is making market research a standard practice. Thus, analyses of prospective markets for shares that companies issue would become more insightful and sophisticated, and they would examine investors’ motives and needs more closely than ever before. Żurthermore, we should remember that in the wake of the transformation of national capital markets into the global capital market it is necessary for companies to take into account changes and shifts that occur in this market. As a result, the role of economic knowledge in the creation on investor relations is now more important than ever. T. M. Ryan and Ch. A. Jacobs indicate three basic components that make up effective corporate IR: the so-called “Three Ds” (Ryan and Jacobs 2005: 89-245) (see Tab. 4.6): 1. Definition – a company needs to communicate to the capital market its nature and the nature of business it conducts by deconstructing its current image and rebuilding it according to investors’ perception, thus creating the so-called value story. 2. Delivery consists of a very active presentation of business operations to appropriate groups of investors, with particular care for transparency, quality of information provided and the improvement of tools and channels used to communicate information to the capital market. 3. Dialogue understood as an on-going, continuous process and a critical factor for building investors’ trust and competing for their capital. 4.6.2 Increasing disclosure as a condition of successful IR. Within the scope of investor relations and investors’ expectations that are created on their basis, both theoreticians and practitioners in the field engage in a lively discussion on the subject of the corporate reporting model. Significant progress already made in this area notwithstanding, there still exists considerable potential for improving the quality of reports by adopting investors’ perspective throughout the entire process. The model currently in place is dominated by financial data, which constitutes but a part of a company's comprehensive view, and provide too superficial an insight into long-term value growth potential. It means that although corporate reporting has entered the phase of accelerated changes, investors still do not receive all the information they need. Furthermore, while an enormous effort is made to create global financial reporting standards, actually very little is done to elaborate certain standards concerning the presentation of contextual information and information about intangible sources of value, while increasing the disclosure in this respect can be beneficial for both sides. A company gains an opportunity to tell the “equity story” as seen through managers’ eyes. It presents sources of value used in the management process, and thus outlines perspectives for long-term value creation, reducing at the same short-term focus. Investors’ benefits lie in more transparency on the part of a company, which allows them to form their expectations rationally and make more rational investment decisions. Achieving such coordinated benefits requires continuous dialogue between a company and investors – a dialogue which regulators and auditors may facilitate, but should not dominate. Ultimately it is companies and investors – the two key powers on the capital market – who need to reach consensus regarding the content of a report on their own (PricewaterhouseCoopers 2007a: 5). As it has been already pointed out, nowadays corporate reports show a tendency to focus on performance results expressed by income and profit, and these are but a few of many important elements in every company’s value supply chain. It seems, however, that for investors more important are those elements which are at the beginning of the chain, namely information concerning value creation: on what basis managers plan to build value and how they plan to achieve it. As the results of previously quoted studies demonstrate, investors attach particular importance to information about: the market (or markets) on which a company operates, its demographic, geographic, etc. changes, corporate strategy together with key risk factors concerning its implementation, resources necessary to carry out the strategy. Of course, such information is more valuable if it contains quantified measures and when it is possible to compare it to other companies’ results. Undoubtedly indicators particular for a given industry (line of business) are critical for a more comprehensive view of a company’s future development. A valuation of a company is in fact made by investors, so it is vitally important for the entire process to deliver to the capital market the information on which they will be able to base their expectations and correctly assess a company’s medium- and long-term prospects. However, as conclusions form the aforementioned research clearly indicate, in spite of the progress, companies rarely define key success indicators and do not use them to determine strategic goals. These factors are also rarely reflected in external reporting. Financial reports published by enterprises are not used as a forum for managers to present their view of a company’s performance, strategies and development prospects to investors and other market participants. Such information is usually featured in presentations prepared for investors and analysts, it appears in small doses in annual reports or on the corporate website. Besides, the level of such disclosures is still far from what investors expect. They demand that companies go beyond the existing legal framework, but they understand the need for discretion when it comes to certain competitive factors. Because in truth, efficient allocation of capital takes place inside the heads of investors before it becomes a reality on the capital market (PricewaterhouseCoopers 2007: 5). Therefore, what managers should make their priority in the scope of information policy is providing information that really influences the investor community’s perception of a company and which reduces investors’ need to look for information elsewhere, where a company cannot control it. The implications of investors’ growing expectations are far-reaching. Undoubtedly, meeting their information needs and expanding provided information packages requires a collection of all kinds of data from individuals and groups involved in the process of crafting and executing strategy, R&D, customer service, branding, or working for local communities and environment. It is the only way to build a fully integrated and comprehensive report. Moreover, in current conditions, companies must make more effort than before to identify information investors need, to assess adopted strategies and evaluate their potential. Further challenges appear in connection with the disclosure of information about factors which executives use in the management process. Usually they are not revealed to the public, since they do not fit into the existing systems and procedures of “producing” information. The need to report on strategy is very strong as well, as it is a significantly neglected area. Hardly ever can we encounter reports that feature all relevant information about strategy, including the identification and explanation of all types of risk, sources and relations which are critical to the successful execution of a strategy. Another significant challenge stems from the IT and communications revolution. It involves mainly the use of the Internet as the platform for the presentation of corporate information. Technology can also help to diversify the format of the communicated content, which enables more extensive reporting and development of a company’s communications strategy. All challenges connected to the expansion of the information package result mainly from investors’ inability to estimate value of something they do not know. But unlike financial reporting, value reporting is not a one-way process. Because while it is relatively easy to calculate EPS, an objective estimation of such elements as market share, customer satisfaction and brand awareness is much more complicated (Chambers 2003: 2). The economic value of each component of resources invested in a given company should become the fundamental attribute of the information system. Such components include, for instance: fixed material assets, financial means and instruments, legal assets, concepts of various business solutions, knowledge, organisational framework for operational actions, management concepts, methodological solutions, relations with customers and other stakeholders (Karmańska 2009: 143). In other words, ascribing a given element the status of a resource with economic value confirms its usefulness in the execution of value growth strategy. Moreover, if the use of a given element will ultimately help to generate higher economic benefits than expected, then this element not only has economic value, but also brings to the business additional value – economic value added (Karmańska 2009: 143). Therefore, in order to create value, a company must include in its internal and external information system all resources which contribute to the generation of economic benefits. The information package issued to capital markets must be expanded and that will allow investors to rationally form their expectations about a company’s performance. There can be no doubt that the contemporary economic perspective completely changes the perception of corporate resources, and consequently also the traditional approach to performance measurement, which should constitute a starting point for the creation of a modern investor relations model. Due to the evolution of the sources of a company’s competitiveness towards intellectual capital, traditional performance metrics are nowadays far from sufficient, since they use conventional accounting information and financial reporting standards, and they mainly analyse relations between profit and various other accounting categories (Edvinsson 1997: 266-373). Deficiencies of accounting metrics and the need to regard a company’s effectiveness from the perspective of equal usage of tangible and intangible assets in the management process have been indicated for years. Eventually they inspired the development of effectiveness metrics based on value added, which are strongly connected to the concept of value-based management (Szczepankowski, n.d.: 3). These metrics include: Economic Value Added – EVA and Market Value Added - MVA (Stewart 1994), Shareholder Value Added – SVA (Rappaport 1998), Created Shareholder Value – CSV (Fernandez 2001), and Economic Shareholder Value Added – ESVA (Michalski 2000: 69-87). Yet even those metrics are rarely reflected in the information communicated to investors, as their use is not very widespread. In view of current changes, the creation of a new IR model requires first of all successful identification and management of intangible assets, which entails the need to create appropriate methods of measuring their value. In this context, it seems that S. Firer from the Monash University and S. M. Williams from the Singapore University ask a very pertinent question: if knowledge is the key to future success, but it is not adequately reflected by traditional financial metrics (and these are the metrics that constitute the base for making managerial decisions), what system will be able to fulfil requirements of the present times and address the needs of modern enterprises? Especially that, as we have previously indicated, financial measures are only a small part of the information package investors demand in order to make rational investment decisions. Information concerning intangible assets allows investors and analysts to create a mosaic of sorts from which they can form opinions about a company’s future. Just like a mosaic, the big picture of the future consists of many small pieces which investors and analysts assemble together (Cole 2004: 12). Numerous studies show that investors often misprice the shares of companies in which intangible assets play an important part (Lev 2004: 109). Sometimes the valuation is inflated, which leads to the loss of a part of the invested capital. But much more often investors undervalue company’s intangible assets. As a consequence, capital acquisition cost grows, which usually leads to underinvestment in intangibles, and thus a limited ability to generate more value. Research clearly indicates that investors very often understate value of companies that make considerable outlays in the field of research and development. Of course, that does not stem from their ignorance, but rather from the awareness that many R&D projects are uncertain undertakings burdened with technological and commercial risks (Lev 2004: 210). Analysts stress as well that investors underprice shares of companies involved in R&D also because expenses in this area are noted in official financial reports in an entirely different way than other intangibles, although these expenses, too, are undervalued. This situation is beneficial neither for investors nor for the companies, who take into consideration the market’s cool reaction and usually limit their spending on intangible assets and funnel available financial resources to much safer, but also much less lucrative improvements of existing solutions. Thus a question arises: why rationally thinking individuals deprive themselves of the chance to increase potential returns resulting from the optimal allocation of means in intangible assets? Undoubtedly one of the reasons are difficulties in access to information about intangible assets experienced by managers and investors alike. The lack of managers’ proper knowledge on the subject of intangibles may be baffling, but if we consider the lack of legal requirements with respect to oversight, the situation is no longer so surprising. Internal problems with intangible assets reporting result in investors’ excessive caution in their assessment. In such conditions, only reliable information and formal procedures for its collection and disclosure, which go beyond existing standards of reporting, enable executives to find additional bases for decisions they make and provide investors with a more detailed insight into a company’s situation and performance. Dynamic development of the concept of intellectual capital induced numerous propositions to include it into corporate reporting. Thus, a new challenge emerges: how to transition from financial to business reporting and to establish better and more efficient communication of information indispensable for a reliable assessment of a company’s activity in terms of value creation?11 Considering the matter of intellectual capital in a company can be compared to studying the roots of its value; they determine its future performance (Ross et al. 1998: 16-17). It follows that many organisations in the community and in the academia, as well as advisors and companies themselves put forward proposals of a new type of reporting – value reporting, which would complete financial information and better represent sources of a modern company’s value (Dobiegała-Korona and Herman 2006: 209). But as yet, there are no standards with regard to intangibles, which constitutes a considerable challenge for theoreticians and practitioners of corporate management. The majority of new concepts focus on the creation of framework for separate reports that would allow companies to inform about A. Gajewska-Jedwabny, Raportowanie wartości. Model Value Reporting zaspokoi apetyt obecnych i przyszłych inwestorów, internal materials of the Polish Institute of Investor Relations. 11 primary sources of their value, i.e. intellectual capital. There exist reports on value added, human capital, social or environmental aspects, or reports on the subject of customers. These are all voluntary disclosures of companies that themselves determine the scope and manner of presentation of the featured information (Marcinkowska 2004a: 84). However, the literature illustrates certain scepticism connected to the measurement and presentation of intellectual capital. Researchers indicate that it might be too ephemeral a concept (Dudycz 2005: 225) and that it contains a considerable measure of subjectivity. Nevertheless, from the vantage point of the creation of a new IR model and purposeful creation of investors’ expectations, measurement of intellectual capital is essential. There are at least three reasons: 1. Growing disproportion between market value and book value of companies. 2. Increasing importance of the intellectual capital as a company’s value driver, which often constitutes the main factor shaping future cash flows, and thus the basis for traders’ investment decisions. 3. Measurement of the intellectual capital enables effective management and investment in intangible assets. When reporting on intellectual capital, companies can use existing models and measures, both quantitative and qualitative (Dudycz 2005: 224-225), as well as indicators and vectors (Harrison and Sullivan 2000). The available methods of presenting IC that companies can use for creating investors’ expectations include: • • Total Value Creation (TVC®) (Upton 2001: 22); Accounting For The Future, or value-added approach to accounting invented by • H. Nash, Sr. (1998); • Balance Scorecard created by R. S. Kaplan and D. P. Norton; • Value Added Intellectual Coefficient – VAIC™ proposed by A. Pulić; • Intangible Asset Monitor developed by K. E. Sveiby (2001-2005); • perspectives; innovation, employee, process, customer and financial (CIMA n.d.), Cockpit Communicator, based on the Balance Scorecard, features five similar Celemi's Intangible Assets Monitor, which monitors three general categories: customers (external structure), people (competence) and organisation (internal structure) (Celemi 1999); • Skandia Navigator (Edvinsson and Malone 1997) which enables gathering comprehensive information about the situation of a company: its past performance (financial perspective), current condition (customer and internal process perspective) • and the future (renewal and development) (Skandia 1998); Ramboll’s holistic enterprise model consists of key reporting areas: values and leadership, strategic processes, human resources, structural resources and consultancy, • which serve for the management of the aforementioned corporate value drivers; The Value Chain Scoreboard™ devised by B. Lev, similarly to other presented models, is a matrix of nonfinancial metrics of business performance (Upton 2001: 46- • 47); Value Creation Index proposed by Cap Gemini Ernst & Young and Wharton Business School identifies crucial nonfinancial value drivers and the capability of specific categories of intangibles to drive company’s market value, so it is possible to • list relative factors that determine corporate value creation in every industry; Value Reporting Revolution is an attempt of a comprehensive approach to corporate reporting and communication with investors, the investor community at large and other stakeholders, oriented on providing information necessary to asses shareholder value creation perspectives. It discerns four planes of reporting: market overview, value strategy, managing for value and financial performance (“value platform”) (Eccles et al. 2001), which allow a company to communicate to its shareholders the logic behind its actions, from the perception of the market, possible opportunities and risks to strategy identification and implementation to the focus on shareholder value • creation activity (Gajewska-Jedwabny 2004: 473-481); IC Rating Model™ developed by K. Jacobsen, P. Hofman-Bang and R. Nordby, Jr. is based on Sveiby’s concept of intellectual capital and divides IC into: human capital, two types of structural capital – organisational and internal organisational capital – and • relational (or external structural) capital (Jacobsen et al. 2005: 570-587); Integrated Reporting which aims to provide more complete and user-friendly corporate information. By combining financial analysis with the analysis of the social, environmental and economic context in which a company operates, integrated reporting should provide valuable assessment of an organisation’s long-term profitability.12 12 http: //www.theiirc.org/ The debate about the necessity of changes in the scope of listed companies’ information policies is conducted also on an international level. Starting with the Jenkins Report (1994) a number of documents has been issued in order to call for the increase in disclosures concerning intangible assets and for the development of new reporting models, with particular emphasis on the presentation of intellectual capital. Notable propositions include: C. źustance’s The Intangible Economy: Impact and Policy Issues, Report of the European High Level Expert Group on the Intangible Economy, European Commission, London 2001; Financial Accounting Standard Board’s (ŻASB) Business Reporting, Insights into Enhancing Voluntary Disclosure, Steering Committee Business, Reporting Research Project, Norwalk, CT 2001; W.S. Upton’s Business and Financial Reporting, Challenges for New Economy, Special Report, ŻASB, Norwalk, CT 2001; and M. Blair’s and S. Walkman’s Unseen Wealth, Brookings Institution, Washington DC 2001. In the late 1990s, the European Commission launched a range of initiatives linked to IC, including the MERITUM project (Canibano et al. 2002) which focused on the study of three areas: classification of intangible assets, management and monitoring of the intellectual capital, and the capital market weakness with regard to IC valuation. The results of the research allowed to produce a set of guidelines for IC reporting. MźRITUM is divided into three sections: “conceptual framework”, “intangible assets management” and “Intellectual Capital Reporting model”. The latter specifies elements that should be disclosed, in particular: corporate vision, description of intangible assets and relevant actions undertaken by a company, as well a system of metrics applied. Interesting initiatives are developed also on the national level. Particularly stimulating is the Guideline for Intellectual Property Information Disclosure (GIPID) prepared in October 2004 by the Japanese Ministry of Economy, Trade and Industry (METI) as an idea promoting the concept of “knowledge-based society”, and encouraging Japanese enterprises to practice “IC-based management”. Danish idea is equally interesting – Guideline for Intellectual Capital Statement (Danish Ministry of Science, Technology and Innovation, 2003) proposes an IC report that includes a combination of four elements, which together present the corporate knowledge management process, combining customers’ expectations with knowledge necessary to meet them. We should also bear in mind that companies more and more often prepare reports on Corporate Social Responsibility, which can constitute an equally useful source of information on intangible value drivers. Of course, this area evokes certain questions and doubts. Is the idea of CSR actually relevant for investors? Or is it only a trendy slogan which conceals dishonest practices? Or perhaps J. Bakan was right to assert that corporations have traits of a psychopathic personality: they care about nothing but themselves, they are incapable of caring for others, and do not experience fear or remorse? 4.6.3. Fear of increased disclosure – fact or myth? Initiatives presented in the previous section of this chapter distinctly illustrate tendencies and attempts to develop an IC reporting model. It should be underlined that investors and analysts eagerly seek out information about intangible value drivers, which determines company’s development opportunities and future market position and, thus, also investors’ expectations and perspectives for value creation. Nevertheless, restriction of such disclosures is a common practice. The authors of Value Reporting Revolution: moving beyond earnings game identify and disprove 10 reasons (myths) why managers are sceptical towards increasing information disclosure (Eccles et al. 2001: 203-208): 1. The market cares only about earnings. Surveys reveal that investors do indicate profit as one of the main factors they take into consideration while making investment decisions. But equally important are: R&D investments, cash flow, capital expenditures, the cost of capital and information about the segment situation. Moreover, investors eagerly seek information about nonfinancial value drivers in such areas as market growth, product development, market share and strategic plans, etc. 2. We already report a lot of information. And yet, the fundamental question concerns not how much information a company delivers to the market, but above all whether this information is right, adapted to users’ needs and expectations. Research confirms that communication gaps are still considerable, particularly in the case of information about customer retention, risk management, the development of a given company’s segment, or economic profit. As we have previously stressed, is not enough to just fulfil the information duty. 3. Once the information is out there is no going back. If the market deems a particular piece of corporate information useful, it will expect more. It should be emphasised that by presenting a wider range of information managers act in their own best interest, since increased disclosure has a positive effect on a company’s market value growth. But it would be wise to remember that the value of information grows, if it can be presented and analysed as a historical trend line and compared to the competition. 4. Producing and reporting information cost a lot. Thanks to the Internet, the cost of providing information to the market decreases dramatically. For the sake of generalisation, we can evoke Moore’s Law and assert that the cost of providing information via the Internet falls by half every 18 months. For companies, it implies enormous opportunities to make significant modifications in their communication policies and to adapt them to the user’s profile. Therefore not the reporting cost, but the cost of generating or “preparing” the information. Certain measures, e.g. customer retention or process quality, are often difficult to estimate and require the development of new measurement methods, which might necessitate considerable commitment. Managers should therefore decide whether having information for the internal decision-making process justifies expenses incurred to generate it. If the management decides that is the case – the disclosure of such information requires only a small additional cost. 5. No matter how much information we disclose, the market always wants more. The size of the communication gap (the difference between the importance a given factor ascribed by the market and users’ satisfaction with the information received on this subject) can vary significantly. Most investors and analysts are generally satisfied with information they receive about earnings or capital expenditure. There are of course exceptions, but we can even assume that the communication gap in this area is practically non-existent. But as the presented research indicates these factors are not considered to be very important or crucial for making investment decisions. Paradoxically, the information which investors desire the most are the worst reported or not reported at all. 6. Bad numbers will hurt our stock price. It is true that if the market believes a particular financial or nonfinancial indicator is important for the value creation process, its bad results will cause the stock process to fall, even if profits remain strong. However, the fact that a measure is reported may positively affect share’s market price, even if earnings stay weak. We cannot escape the truth that the market rewards or punishes companies and their performance regardless of whether their basic measure is profit or another important variable. 7. Some of measures are not completely reliable. It is true that lack of reporting is better than providing false or erroneous information. It is also true that most companies do not possess adequate systems to measure certain key parameters of their business performance, especially intangibles. But certainly efforts made by enterprises in this area are highly praised by the market. As an illustration we can list some companies that have implemented the balance scorecard system: AT&T, General Motors, Johnson&Johnson, NovoNordis, and others. 8. We are afraid that our competitors will use the information. Such a possibility certainly exists, but the fear is exaggerated. If a company wants to obtain information about its competitor, it has a number of available ways to do it, including consulting services, corporate intelligence, or hiring a manager of a competing business. Moreover, even if a company discloses information previously unknown to their competitors or which the competition could not have obtained, using it to achieve competitive advantage is usually much more difficult that it is generally believed. 9. Our customers and suppliers could learn how much money we really earn. Suppliers and customers are less interested in how much a company earns, and more in the way in which the cooperation with a given business can help them to achieve competitive advantage. If the cooperation turns out to be beneficial, they will be willing to continue the partnership. We should also remember that suppliers and customers react mainly to events on the products/services market, not on the capital market. 10. We’ll get sued. The risk of a lawsuit following a disclosure of inaccurate forecasts is a real possibility, especially in the USA. Such risk often seriously hinders managers’ willingness to increase disclosures. It is therefore an area which should be carefully looked at by regulators. The Safe Harbor Statement introduced in the USA made it possible to moderate this type of risk considerably. The delivery of the information concerning intangibles to capital markets can be limited as well. J. Holland and U. Johanson (2003: 465-486) indicate at least three possible underlying reasons: • • the capital market might not fully understand the potential for value growth that investments in intangibles may unlock, even if capital market players understand the connection between intellectual capital and corporate vision, they will probably hesitate to invest in intellectual capital due to the lack of conviction and confidence in methods of measuring intangible assets, • lack of trust with regard to whether used measures are subject to the management’s control can be problematic as well. There also exists the ownership problem when it comes to certain elements of the intellectual capital, such as people (Johanson 2003: 31-38). M. Garcia-Ayuso points to four factors which influence the capital market’s inefficiency in terms of IC valuation (2003: 18-30): • • the quality of nonfinancial information and lack of information about factors that create value, i.e. true sources of a company’s competitiveness, imperfections of the market and the lack of markets for most IC components, as • well as the lack of widely recognised valuation methods, • in their decision-making process, limited possibilities for financial analysts and investors to include IC information unethical behaviour of managers, which prevent market participants from gathering and processing relevant and reliable information about the intellectual capital. Furthermore, although investors demand increased disclosures of information about intangibles, they seem not to acknowledge the value of reports concerning the intellectual capital that companies prepare. Thus the role of such reports in the creation of investors’ expectations is minor. “Żor intellectual capital disclosure to be perceived as relevant from a capital market perspective, the information should be disclosed as an integral part of a framework illuminating the value creation processes of the firm” (Bukh 2003). In other words the correct assessment of information concerning intangible assets by the capital market requires a simultaneous occurrence of two processes: the identification of IC components as separate assets and presenting them in the context of a business model, which means the necessity to clearly determine how the elements of intellectual capital combine with the value creation process (Mouritsen 2003). In this context, new models of IC reporting are criticised for not including enough details concerning the relationships between particular components of intellectual capital (Martin 2004) and between intangible assets and physical capital, which all in fact form an interdependent bundle of resources (Marr et al. 2004: 312-325). There is no doubt that information’s utility is also conditional on the possibility to compare certain values in different periods and firms (Johanson et al. 2006: 478). Intangible assets and the knowledge management process are unique – they depend on the character of a business, its size, history, and context. Therefore the form of a report on intellectual capital that will be adopted in future should be flexible enough to enable the understanding of the intangibles management logic in a particular company. Undoubtedly that can make comparative analysis of different enterprises more difficult. 4.6.4. Benefits resulting from increasing a company’s openness with information Openness with information inspires not only (more or less justified) fears. We can hardly overlook benefits which information disclosures provide for those companies that are truly committed to the entire process, thus meeting growing information expectations of their investors. Firstly, the expansion of the provided information package increases the understanding of the business activity conducted by a company. Thus, it helps to improve the perception of the corporate management process and increase management’s efficiency. The need to meet investors’ information expectations undoubtedly creates an opportunity for managers to consider the level of detail and the scope of information used in the management process, decide which is the most relevant from the investors’ perspective, and devote appropriate attention to those particular issues. At the same time, the challenge of sharing information more openly offers managers a more comprehensive image of the company and its performance, as well as a new view of its stability. Secondly, the increase in the amount of disclosures contributes to the betterment of relations with a company’s stakeholders. Żirms which communicate efficiently provide their investors and other groups connected to the business with an insight into factors that drive their competitiveness, and clearly demonstrate why the strategy chosen by the management is the right one. Thirdly, the increase in corporate transparency undoubtedly improves the quality of the management and gives companies an opportunity to build their reputation, increase market valuation, reduce capital cost as well as attract and maintain the most gifted employees. Fourthly, effective communication with investors is certainly a fundamental tool for building investors’ trust in a company. Trust is a crucial factor cementing every kind of partnership. It is even more important in the conditions of crisis and the situation of “risk society” we undoubtedly face nowadays ( ądło 2009: 426). Trust is a function of risk perception, and risk is in this case understood as the probability that negative consequences of actions taken under uncertainty will occur (Grudzewski et al. 2007: 36). If so – what constitutes the foundations of investors’ trust is particular knowledge and information about a company. It follows that trust grows as the amount and variety of reliable information delivered to capital markets increases. Due to the currently growing risk exposition, the category of trust is more and more often evoked. On the capital market, trust is of particular significance in three distinctive areas (Orłowski 2004: 64): • • • trust in the way the market works (its transparency and efficiency of market mechanisms); trust in market participants (their integrity); trust in regulations and institutions supervising the market (which guarantee the opportunity for lucrative investment). The most important elements that constitute trust for the public market are (DiPiazza and Eccles 1997: 3-7): • • • transparency demanded by investors and other stakeholders, which seems indispensable in the creation and protection of corporate value, the accountability among the participants of the reporting supply chain, the honesty of individuals involved in the reporting process. According to S. A. DiPiazza and R. C. Eccles, the Corporate Reporting Supply Chain is a diagram that identifies roles and relations of groups involved in the reporting process, which means preparation, communication and application of information disclosed by a company (see Fig. 4.9). Each link of the chain must be infallible and reliable (DiPiazza and Eccles 1997: 10-11). 4.6.5. Investor relations versus risk Undoubtedly, the expansion of the information package delivered to capital markets by companies has become an urgent necessity, mainly due to turbulences on global financial markets and growing information demands of the environment. Yet, a question appears: what are the limits of accuracy concerning information included in reports? Is it possible to create investors’ expectations concerning a company’s future performance so that they precisely reflect its fundamental value? It seems that the main difficulty lies in reporting only a company’s economic value. On the one hand, forecasting conditions of a company’s operations in the future is considerably limited by the extreme dynamism of the current markets. On the other hand, these limitations concern expressing current value of the expected cash flow, i.e. discounting. The problem becomes even more complex in the case of an attempt to measure and report intangible value generators. Such a procedure may cause organisational difficulties and entail costs disproportionately high to information benefits which a report would gain. Said complexity is enhanced in the case of periodical reports which public companies are legally obliged to prepare. Hence the question about the information efficiency of the cost incurred in the process of generating reporting information (Karmańska 2009 : 300). In view of the fact that such a cost is difficult to identify, and its efficiency is measured mostly from the perspective of stakeholders’ information needs, A. Karmańska formulates additional questions (2009: 303): • • How far should we allow ourselves to be guided by information’s utility or importance when making a decision? What can identify that limit, and is it possible to measure it? Should we use complex procedures for the valuation of assets – whose economic value can be determined only after a very detailed analysis – if its importance for users’ decision-making may be insignificant? Risk with regard to value reporting accuracy and maintaining investor relations may encompass the following issues (Karmańska 2009 : 322-347): • Improper organisation and improper course of the value measurement process. It may result from the failure to secure access to appropriate information, limited ITorganisational support (or lack thereof) from the company’s management, limited knowledge about the direction and character of future business activity, lack of cooperation with people who due to their function in the enterprise observe both the outside and the inside of the firm and are able to identify early-warning signals, should they come from either. • Lack of company’s skills to adapt to dynamically changing conditions of business activity which affect the quality of management. Poor quality of management is an important source of risk, since it undoubtedly contributes to the destruction of value. Measurement and reporting risk may stem from a carelessly developed strategy, low awareness of the competitive potential which makes it impossible to fulfil the requirements of the changing environment, and certain external conditions. • Lack of professionalism or bad intentions on the part of both executives and those responsible for investor relations and a company’s information policy, which may manifest for instance as: managers’ and IR personnel’s reluctance to address the public, lack of competence, or knowledge about the way financial market works, or lack of commitment to the improvement of investor communications quality. • Misunderstanding the nature of current conditions of IR, which may manifest itself as: (1) using only a very narrow and limited set of tools to communicate with investors, (2) placing IR far from the top management in the organisational structure of a company. As a result, a company may be cut off from important information, or the acquisition of information may be hindered. (3) Lack of any analysis of feedback given to the company by investors. • Providing the market with wrong or insufficient information, inadequately adapted to users’ needs, or communicating them at a wrong time. • Awarding information privileges to certain shareholders which may result from a company’s dependence on a single investor or investors from a single country, as well as from the shareholders’ inactivity. • Attempts to manipulate the market, or in particular the price of financial instruments. Such actions may consist of making transactions which are misleading for other market players, transactions which artificially fix prices, spreading misleading or false information, and expressing opinions that affect the price of financial instruments without revealing the existing conflict of interest. • Legal risk, connected with potential infringement of those provisions of the law which relate to the information duty. The risk concerns particularly the treatment of confidential information, price manipulation, providing false or incomplete information, or unequal treatment of investors. The considerations presented above clearly indicate that limitations and risks concerning the measurement of a company’s economic value and the functioning of investor relations may engender a number of problems connected with credibility of information provided by the companies. It is critically important to resolve the abovementioned issues, because otherwise a company’s value, and thus also investors’ expectations, may become subject to manipulation, especially in the situation of turbulence on financial markets. To conclude the discussion featured in this chapter, we can assert that undoubtedly information is one of the most important factors that form investors’ expectations, and consequently also stock prices on the capital market. The research carried out by J. E. Burnett, C. Carroll and P. Thistle reveals that incoming information is in two-thirds responsible for stock price changes on the capital market (Burnett et al. 2008: 1). The impact of information on rates of return is a matter of never-ending studies in the field of corporate finance and financial market operations. In theory, every new piece of information leads to changes in expectations concerning future cash flows, the risk of these flows, and finally to changes in expectations about the rate of return on shares. Conducted studies focus mostly on the analysis of short-term stock price movements in response to arriving information. It seems however that with proper policy a company is capable of purposeful creation of long-term investors’ expectations, inspiring in a sense a more fundamental response from the capital market. Therefore the potential exists to include investors’ expectation in the value-based management process and to make a transition from value-based management to expectationsbased management. REFERENCES 1. Akert RM, Aronson E, Wilson T (2004) Social psychology. Pearson/Prentice Hall, New York 2. Andrzejewski P (2003) Sztuka budowania wizerunku osób, firm i instytucji. Forum, Poznań 3. Black A, Wright P, Bachman JE (1997) In search of shareholder value. 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Source: Corporate Governance and the Financial Crisis: Key Findings and Main Messages, OECD, June 2009, p. 15. Fig. 4.5. Distribution of answers to the question: Would you say that investors’ demands concerning IR are changing? (in %) – listed companies sample. Source: Dziawgo (2011: 258). Fig. 4.6. Importance vs adequacy of key aspects of financial reports. Source: PricewaterhouseCoopers 2007b. Fig. 4.7. How well is the information provided by companies adapted to investors’ needs? (in %). Source: Dziawgo (2011: 254). Fig. 4.8. Gaps in communications system. Source: Eccles et al. (2001: 130). Fig. 4.9. Corporate reporting supply chain. Source: DiPiazza and Eccles (1997: 436). TABLES Tab. 4.1. Technical analysis indicators. Trend indicators • DEMA • Moving Average Convergence Divergence (MACD) • Parabolic SAR • Moving averages • Price Oscillator Volatility indicators • Average True Range • Commodity Selection Index • Bollinger Bands Source: own work. Momentum indicators Support and resistance Market power indicators indicators • Accumulation • Accumulation/ Swing Index Distribution • Commodity • Money flow Channel Index • Public trading • Stochastic oscillator • Trix • Williams %R • Relative Strength Index (RSI) • Rate of change (ROC) • Pivot Point Tab. 4.2. Accounting and financial reporting regulations against a backdrop of the 1973 oil crisis and dissolution of the Soviet Union. • • • • • • • 1973 oil crisis 1973 Financial Accounting Standards Board (FASB – USA) 1973 International Accounting Standards Committee (IASC – London) 1974 Basel Committee on Banking Supervision (BCBS – Switzerland) 1978 EU Fourth Accounting Directive – regulations on financial reporting for a single firm 1983 EU Seventh Accounting Directive – regulations on financial reporting for consolidated accounts 1988 IASC begins to work on standards for recognition, measurement, disclosure and presentation of financial instruments • • • • • • • • 1988 Basel Capital Accord (Basel I) • • Source: Kutera and Surdykowska (2009). Dissolution of the Soviet Union 1989 IASC defines asset, liability, equity, income, expenses, profit and loss 1992 Basel I comes into effect 1995 IAS 32 Financial Instruments: Disclosure and Presentation 1995 EU begins to introduce new regulations concerning financial information 1996 Amendment to the Capital Accord to Incorporate Market Risks 1998 IAS 39 Financial Instruments: Recognition and Measurement (LTCM) 1998 IAS 38 Intangible Assets June 1999 the first consultative document on proposed amendments to the Basel Capital Accord 2000 IAS 39 Financial Instruments: Recognition and Measurement – new version of the standard January 2001 the second consultative document concerning the Basel Capital Accord Tab. 4.3. Proposed solutions for eliminating existing sources of corporate governance dysfunctions. System component Managers’ remunerations Proposed solutions • Increase the transparency of the existing remuneration scheme; a company should be able to explain how its performance is linked to executive pay and how the remuneration scheme relates to risk. • • • • • Supervisory board • • • • • Risk management system • The construction of a remuneration scheme should be oriented on long-term goals. Better adjustment of remuneration scheme to the company’s needs (more flexibility of applied solutions). Good practices: ensuring proper oversight standards, including the participation of non-executive directors and independent boards members, in the process of remuneration scheme creation. Presenting remuneration policies during general meetings and subjecting it to shareholders’ appraisal. Financial institutions should comply to The Principles for Sound Compensation Practices prepared by the Financial Stability Forum. Remuneration policies should be designed in such a way as not to encourage taking excessive risk. Create a competent and independent board (balance between formal independence and necessary competence). Increase shareholders’ involvement in the appointment of the supervisory board. Separate the function of CEO from the chairman of the board. Good practice: building (by the board itself) policies oriented towards identification of competences most useful for the board. Identify professional skills which can help increase the board’s effectiveness. Companies from entrepreneurial and financial sectors alike should identify operational, market and strategic • • • • • • Shareholder activity • • • • • risk as well as risks particular to their business. The objective of the risk management system is to understand the risk, manage it, and if necessary – communicate. Institutions responsible for creating legislation or good practices should be aware that effective risk management does not aim at eliminating risk. The board should review and provide guidelines for the alignment of a company’s strategy with the approach to/orientation on the risk, and guidelines concerning internal risk management structure. Good practice: ensuring independence of risk management and control from profit centres and independent. Disclosure of the risk management process and risk assessment; communication with the market. Good CG practices should to a larger extent include recommendations concerning market management – raising awareness and increasing the level of recommendations’ implementation. Align shareholders’ and executives’ interests in a longterm perspective. Increase shareholders’ activity, institutional investors’ in particular. Increase companies’ orientation on building relations with their shareholders. źase barriers for shareholders’ votes, introduce remote voting via the Internet. Eliminate barriers which limit participation in the general meeting of shareholders (e.g. share blocking), implement mechanisms which help to increase participation in the general meetings (e.g. online voting). Source: Koładkiewicz 2010, p. 92. Kirkpatrick 2009, The Turner Review. Tab. 4.4. Which aspects of a company are the most important from the investors’ perspective? Financial performance Quality of risk management process Transparency Quality of reporting Product innovation Independence from large financial institutions Size Source: PricewaterhouseCoopers (2008: 9). 72 % 49 % 46 % 33 % 27 % 18 % 14% Tab. 4.5. New approach to investor relations. Traditional IR New Approach to IR Strategy Supports strategy and makes sure it is communicated to the capital market participants. Equity Story Communicates investment theses based on operations and marketing strategies. Stock market reconnaissance Observes the stock market. Shareholder Analysis Tracks stock ownership (owners’ names, amounts of stock in their possession) through available databases and resources. Considers feedback an important factor, but does not see the need to maintain contact with the investor community. Participates in the strategy formulation process with the benefit of understanding its impact on the capital market. Prepares and communicates complete investment theses that hinges on a company’s valuation. Fully understands market valuations and reads price fluctuations on the market. Tracks investors and creates them by looking at comparable companies. Feedback The role of IEO (Investment Executive Officer) Supports the CEO, helps senior management to provide information to the market. Source: Ryan and Jacobs (2005: 80-81). Considers feedback and relations with the investor community to be fundamental factors affecting a company’s market valuation. A strategic position in a company; participates in the creation of value growth strategy, helps to assess the value of strategic variants and to make decisions. Tab. 4.6. Components of effective corporate IR. Definition • Review of information delivered by a company to the market, particularly financial reports, periodical reports, press releases, information concerning price movements on the market and information concerning executives • Vision and philosophy, and both current and future business activity, which provide a fuller image of a company and outline the competitive landscape. • Identification of base groups and particular benchmarks • Estimation of a company’s relative value in comparison to others in the base group • Gathering industry intelligence, i.e. information about investors’ expectations and demands directed to the industry and enterprises which belong to it. Delivery • Identification of the IR target audience • Building and perfecting the structure of the investor relations process • Identification of tools and channels of communication with the investor community Source: Ryan and Jacobs (2005: 89). Dialogue • Building and maintaining relationships and mutual trust between a company and capital market players • Meeting the investor community: road shows, investor days, conferences, presentations, one-toone meetings, etc. • Preparing a response system to both positive and negative events