9, “Is Doing Good, Good for Business?” I examine whether it makes sense for corporations to engage in environmental, community, poverty-reduction, and health-care activities, even if they don’t enhance the bottom line. I conclude that these days it’s irresponsible not to be socially responsible and offer answers on how much, where, and when.
Chapter 10, “In the Long Run, We’re All Dead” (John Maynard Keynes’s immortal—or, rather, mortal—quip), opens the third theme: owners versus managers. I start by removing a major obstacle to effective interaction with shareholders: the popular belief in investor myopia (short-termism). The evidence I present conclusively shows that long-term investors dominate the market, and most shareholders care a lot about your company’s long-term prospects. Accordingly, don’t waste time and energy lamenting investor myopia and appeasing short-term-oriented investors. But, while most investors aren’t myopic, short sellers definitely are, and I suggest how to deal with them.
While not necessarily myopic, “activist” investors can make life hell for managers and directors. In chapter 11, “Breathing Down Your Neck,” I deal with the worldwide rise in shareholder activism, particularly the recent strain led by hedge funds. I show that, contrary to widespread belief, hedge fund and institutional investor activism is often a good thing, driving up shareholder value and improving corporate governance. Based on a profile of targets of activism that I develop, you will be able to ascertain how vulnerable your company might be to activist attack, and what you should do if it were to happen.
In the wake of the corporate scandals of the early 2000s and the ensuing legislation, some boards are coming to resemble shareholder activists. Directors are increasingly assertive in overseeing corporate performance and managerial conduct, evidenced by growing managerial turnover. In chapter 12, “Looking Out for You, Dear Shareholder,” I take the unconventional view that the relentless move toward a full monitoring board has gone too far. In many cases, independent directors lack expertise in the company’s business and technology, depriving managers of much-needed advice. I call for a rebalancing of the board and other governance mechanisms to enhance both the monitoring and advising of managers. A friendlier, more effective board, so to speak.
Managers’ compensation is a major irritant to shareholders and the public at large. I analyze the thorny issues of compensation in chapter 13, “Excess or Excellence?” and conclude, based on evidence, that the major problem with managers’ pay is the prevalent weak link between compensation and company performance. I point at the urgent need to substantially restructure managerial compensation systems to streng-then their link with long-term value enhancement and to curb manipulation and abuse.
Chapter 14, “What Then Must We Do?” distills the specific prescriptions and action plans—operating instructions—that conclude each chapter into a coherent corporate capital markets strategy. Essentially, I provide a comprehensive prescription for what to do and not do to satisfy investors.
Chapter 1
It’s Not the End of the World
What to Do—and Not Do—When Faced with Missing the Consensus Earnings Estimate
In This Chapter
Why a one-penny miss of the consensus is so deleterious.
What factors determine investors’ reaction to companies’ results.
Why high-growth companies that disappoint investors are hit hard.
What actions managers can take to avoid a consensus miss, and its consequences.
What course mitigates investors’ response to disappointments.
On June 26, 2007, the Kroger Company reported a 10 percent rise in first-quarter profits. The supermarket chain’s shares, however, fell 4.7 percent (the S&P 500 rose 0.6 percent).1 What gives? Kroger’s EPS, coming at $.47, missed the analysts’ consensus earnings estimate by a penny—the dreaded consensus miss.2 What happens to other companies that miss the consensus? Will their price drop further and linger on in a funk, or pick up with the improvement in business fundamentals? What types of companies are penalized harshly for missing the consensus and which remain largely unscathed? On the bright side, what happens when you “make the numbers”—meet or beat analysts’ estimates, or surpass last year’s EPS? And does it all matter beyond the few days surrounding the earnings release? The extensive evidence on these and related questions dealing with what is often dubbed “the earnings game”— managers’ continuous struggle to meet investors’ expectations—is highly revealing and will be analyzed next. At the chapter’s end, I advance a consequence-mitigation action plan for executives facing the specter of disappointing investors. In a nutshell, as indicated by this chapter’s title, missing the consensus, if dealt with appropriately, is not the end of the world. Far from it. In contrast, desperate attempts frequently taken to avoid disappointing investors by a last-minute sales blitz or cost cuts, an earnings boost from a change of accounting procedure, or—worst of all—manipulating the numbers are at best ineffective and often seriously counterproductive.
The Not-So-Bell-Shaped Earnings Surprises
Many wonder why investors take so seriously an earnings consensus miss, even by a penny. Simply, because relatively few companies get entrapped in this predicament. Look at figure 1-1 from Mei Feng’s 2008 study of quarterly EPS surprises, which displays the difference between reported EPS and the last consensus estimate available prior to earnings release. Feng’s sample is very large and representative: 180,000 quarterly observations from 1988 through 2005, an average of 2,500 companies per quarter. The highest bar, situated in the center of the graph, indicates that roughly 24,000 observations (about 13 percent of the sample) were perfect hits, where reported EPS matched the consensus to the penny. Many companies fared even better: the three successively decreasing bars to the right of zero surprise indicate that about 47,000 cases—over a quarter of the sample—beat the consensus by $.01 to $.03. Thus, a whopping 71,000 cases, almost 40 percent of the sample, meet or beat by $.01 to $.03 the analysts’ forecasts. This, mind you, is the optimal play of the earnings game. You want to beat the consensus, but not handily, lest analysts raise the bar substantially for next quarter or year.
FIGURE 1-1
Earning surprises: Reported EPS minus analyst consensus estimate, 1988–2005
Source: Mei Feng, “Why do managers meet or slightly beat earnings forecasts in equilibrium? An endogenous mean-variance explanation,” working paper, Katz Graduate School of Business, University of Pittsburgh, 2008.
In sharp and painful contrast, the three bars to the left of the perfect hit indicate that only about 27,000 cases (15 percent of the sample) miss the consensus by $.01 to $.03. Herein lies the main answer to the opening question: missing the EPS consensus estimate even by a few pennies takes a heavy toll on the stock because it places you in the minority of underperformers. Not good company to keep. Moreover, given that the majority of companies manage to avoid missing the consensus, those who get entrapped are presumed not only to come short of expectations, but also to have tried every means available, legit or not, to get over the consensus hump and failed. This obviously suggests to investors the existence of serious business issues lurking in the background, causing the strong negative reaction to even a one-penny miss.3
There is another remarkable feature in figure 1-1. In such a large sample of EPS surprises, encompassing eighteen years of boom and bust and including thousands of companies operating in most economic sectors, it is reasonable to expect the earnings surprises to be bell-shaped—symmetrically distributed around zero: a certain number of consensus matches at the center, flanked on both sides by a roughly equal and decreasing number of negative and positive surprises. But look closely at the figure and you will see a surprising—no pun intended—pattern of earnings surprises. Centered on top of zero surprise is, as expected, the highest bar, but to its right are the two next-highest columns, indicating