Chapter 20

How Companies Soothe the Shareholders

In This Chapter

Attending annual shareholder meetings

Continuing to invest by using company incentive programmes

Using company communications on the Web

Happy shareholders don’t necessarily mean a happy company, but they’re a good start. Although a company collects most of the money generated from share transactions at the time when the share is first sold to the public during an initial or secondary public offering, shareholders still hold a bit of power over management. Angry shareholders showed what their wrath could do when their lack of support for Disney CEO Michael Eisner helped oust him from the chairmanship of the board in 2004. In the UK, investors in Spirent voted against the board in favour of a takeover by Sherborne Investors, causing the ousting of the main board executives.

Sending out half-yearly and annual reports aren’t the only strategies companies use to keep their shareholders informed and happy. Other activities include annual general meetings, extraordinary meetings, Web site services, e-mails, share-investment plans, and individual investor contact. In this chapter, we review the steps that companies take to inform their investors of operations and to respond to any investor concerns.

Knowing What to Expect from an Annual General Meeting

A company must, at the very least, hold an annual general meeting for its shareholders. These events are often gala affairs that are more like a carefully orchestrated pep rally than a place where you can get solid information. The company’s top officers make presentations highlighting what they want you to know and put on a show that closely resembles what you can find in the glossy portion of an annual report.

The big advantage of being at the company’s annual general meeting is that you can ask questions, which you can’t do if you just read the financial reports at home. Prepare yourself before the meeting by reading the recent financial reports, as well as annual reports for the past couple of years, so you’re fully armed with detail about what has gone on in the past. Make a list of questions that you want answered by the company’s executives so you’re ready to ask them when they open up the floor for questions.

If you’re a shareholder, the company notifies you about the date and location of the meeting. Note that if shareholders are unhappy with the corporation’s board or its executives, annual general meetings can turn into major shouting matches when the floor is opened to questions and comments. In addition to asking questions, shareholders vote on any open issues.

Almost every annual general meeting includes the election of at least some members of the board of directors. Most companies stagger the election of board members over a number of years so that the entire board doesn’t change in one year.

Other issues that involve major changes to the way the company does business are also voted on. For example, if the company plans a major change in executive remuneration, it’s voted on at the annual general meeting. In the past shareholders rarely interfered with boardroom pay but there have been a number of shareholder revolts against some very large compensation packages that directors were proposing to pay each other.

Sometimes, shareholders add their own issues to the agenda. For example, environmentalists who own shares in the company may seek a shareholder vote on how a company gets rid of its waste (to ensure that controls to protect the environment are in place) or how a company develops land it owns near a wildlife preserve (to be sure wildlife is protected during and after construction).

Innovative companies see annual general meetings as a way to communicate effectively with their investor base. The problem for many companies is that most shareholders don’t show up. But the Internet can help reach shareholders who don’t attend. Some companies place all their meeting materials on a Web site, and some companies also webcast the meeting itself and archive it for shareholders who aren’t able to watch it on the Web site when the meeting takes place. HBOS is a good example of this.

Culling Information from the Annual General Meeting

Today, investors get information not only by reading press releases or newspapers, but also by attending annual general meetings. (See the preceding section ‘Knowing What to Expect from an Annual General Meeting’ for more information on these meetings.) Special events – such as a change in company leadership or the purchase of another company – can also prompt companies to set up extraordinary general meetings. By listening at these meetings, you usually get more details about whatever issues are being discussed.

The company’s chief executive officer (CEO), chairman, and chief financial officer (CFO) typically participate. They usually start by discussing the recently released financial reports or by explaining the impact that any special event has on the company; then they usually open the meeting to questions.

The question-and-answer part of the meeting is often the most revealing. During this portion of the meeting, you can judge how confident senior managers are about the financial information that they’re reporting. Questions from the audience usually elicit information that press releases or the annual or half-yearly reports haven’t revealed. Analysts and big institutional investors rarely ask the questions since they can talk to directors on a different platform; you can learn a lot by listening to conversations between directors and investors.

Listen closely to how the company’s senior managers answer questions. Often during this question-and-answer period, management answers many questions that you may have. If not, don’t hesitate to write or call the investor relations department of the company to get an answer to a specific question you may have about the financial report or the special event discussed during a meeting.

The language participants use at such a meeting is different from the language you use every day. Familiarise yourself with the most commonly used terms before attending your first meeting. We list most of the key terms and abbreviations used during the meetings in Part III of this book, where we discuss analysing the numbers. Get comfortable with terms like earnings per share (EPS), EPS growth, net income, cash, and cash equivalents.

If you hear a term you don’t understand, write it down, and research it after the meeting. Then the next time you go to one, you’ll have a better understanding of what’s being discussed.

Listening between the lines

Pay attention to how the executives handle the meeting and to the words they use. When management is pleased with the results, you usually hear very upbeat terms, and they talk about how positive things look for the future of the company. When management is disappointed with the numbers, they’re more apologetic, and the mood of the meeting is more low-key. Rather than talk about a rosy future, they’ll probably explain ways in which they can improve the disappointing results.

You’ll most likely need to listen to more than one meeting held by a particular company before you start picking up the nuances and moods of the executives. Try attending as many meetings of those companies whose shares you own as you can. Whether a shareholder or not you can listen to a recording of it after it occurs. Many companies post recordings of their annual general meetings on their Web sites, just like they post press releases.

Take the time to read the financial reports before the meeting so you’re at least familiar with the key points that management will discuss during the meeting. After you’ve attended a meeting and read the press reports about a particular company, you’ll find that the information management discusses will become much clearer to you.

Here are a few areas you’ll want to pay attention to:

Earnings expectations: All meetings about a company’s financial results include information about whether or not a company has met its own earnings projections or the projections of financial analysts. If a company misses its own earnings projections, the mood of the meeting will be downbeat, and the share price is likely to drop dramatically after the meeting if it has not already done so in advance of the meeting.

That doesn’t mean you must sell the shares you own, if you happen to be a shareholder. In fact, if you’re at the meeting because you think you’d like to buy more shares, you might want to do so after the share price is driven down by the bad news. The key for you as a shareholder is to analyse what is being said and whether you think the company does have a good chance of turning around the bad news. Good news, on the other hand, can drive the share price higher. Be careful not to jump on the bandwagon right after major good news is announced. Usually, the share price will fall back down to a more realistic price once the initial rush to buy is completed.

Revenue growth: Listen for information about the company’s revenue growth and whether it has kept pace with its earnings growth. During an economic slowdown, watching revenue growth becomes very important, because a company can play with the numbers to make them look better. In fact, some companies practise what is called ‘window dressing’ (using accounting tricks to make a company’s financial statements look better) to make sure their earnings meet expectations. Earnings growth is easier to manipulate than revenue, so earnings usually become part of that window dressing. Growth in revenue is the key to continued earnings growth in the future. We talk more in Chapter 22 about how a company can manipulate its results.

If you hear numerous questions about revenue-growth figures, such questions may be a sign that shareholders suspect a problem with the numbers or are very disappointed with the results. When you hear shareholders’ questions about revenue or any other issues over and over again, take a closer look at these numbers yourself. Do further analysis and research before you decide to buy or sell the company’s stock.

You may find judging the mood of the shareholders or the company executives hard when you go to your first meeting, but as you research more and more about the same company, you’ll be able to judge more easily the mood of meetings, press releases, and other types of information flow.

You can judge whether or not the executives are confident in their reporting by how quickly they answer questions. When executives are comfortable and confident in the numbers that they’re reporting, they answer questions quickly, without rustling through papers. If they’re very cautious with their answers and are constantly taking time to look through their papers, you can be sure they’re not comfortable with the report and must carefully check themselves before answering the questions. Sometimes, they may take a long time to answer a simple question. If company executives seem unsure or respond slowly, take this as a red flag that you need to do a lot more homework before making any decisions about buying more shares or selling the shares of that company.

Looking towards the future

Listen to the vision that the company’s executives portray for the future. Does the vision they present inspire you, or do you think the executives didn’t present a clear vision for the company’s future and how they plan to get there? If you find the executives uninspiring, there’s a good chance that they’re not doing a good job of inspiring their employees either. If you see a downward trend in the company, the lack of inspiration may be one of the reasons for that trend. When company executives lack inspiration for the company’s future, you have good reason to stay away from investing in that company.

Keeping employees happy is important for the future of any company. During meetings, you can judge whether or not employees are satisfied by listening for information about the success or failure the company is having attracting new employees or retaining existing ones. If the company reports a problem with either of these two things, trouble may be on the horizon. High employee turnover is bad for the growth of any company. And if a company has trouble finding and recruiting qualified employees, that, too, is a bad sign for the future.

Don’t ever plan to buy or sell shares based only on what you hear during meetings or read from material the company sends you or puts on its Web site. Use them as one more way to gather information about a share that you’re thinking of buying or for tracking shares that you already own.

Checking Out How the Board Runs the Company

Corporate governance is the way a board of directors conducts its own business and oversees a corporation’s operations. Ultimately, the board of directors is liable for every decision that the company makes, but in reality, only major shifts in the way the company operates make it to the board for decision. Most day-to-day decisions are made by the company’s executives and managers: Shareholders need to know about the major decisions that are taken up to the board. For example, if the executives recommend that the company take on a new product line that would involve a large investment of cash, the board would be consulted for this decision.

The shareholder landscape changed dramatically after the corporate scandals of the 2000s exposed severe corporate governance problems, beginning with the collapse of Enron. Today, shareholder groups, many led by institutional investors such as pension plans and mutual funds that own large blocks of shares in various companies, closely watch the following four major issues in the companies in which they own shares.

Composition of the board of directors: Shareholder groups monitor the make-up of the board, how board members are chosen, and how many members serving on the board are truly independent – meaning that they’re not directly involved in the day-to-day operations of the company. Outsiders prefer that a majority of the members of the board of directors are non-executive directors – that is, they’re not involved in the day-to-day operations of the company. They are committed to the long-term success of the company but not if it tries to take short cuts on, for example, health and safety. They also look for unnecessary risks and any skirting around legal considerations.

Remuneration packages for board members and CEOs: These details are on public record now in the annual report. In addition, shareholders must approve of, or be notified of, any major benefits or compensation offered to the company’s executives, such as share-option plans (offers to buy company stock at prices below market value). Shareholders complain bitterly if they believe executives are receiving excessive remuneration.

Takeover defences and protections: In some cases, board members place defences against the possibility of a takeover of the company. For example, Comcast unsuccessfully attempted a hostile takeover of Disney during the famous battle between shareholders, led by Roy Disney, who was attempting to oust Eisner. Sometimes these defences help protect shareholders from a corporate raider that wants to buy the company and sell off the pieces, which can leave shareholders with shares worth very little. Other times, these defences prevent the takeover by some other company that may benefit the shareholders but not the current management team and board of directors (especially if the leadership ranks would change under the new owners, and they could lose their jobs). Shareholder groups watch whatever takeover defences or protection are put into place by the board to be sure the best interests of the shareholders are being protected, not just the best interests of the directors and the management team.

Audits: A primary responsibility of the board of directors is to review the audits of the company’s books and be certain that they’re being done properly by both the internal and the external auditors. Good corporate governance requires that independent board members make up audit committees. Prior to the Enron scandal, many audit committees (even if they existed) weren’t independently run, which allowed company insiders to control not only how the money was spent, but also how the money was being recorded in the company’s books and how the financial results were reported to outsiders. This insidious practice allowed top executives to more easily hide any misdeeds or misuse of funds. (For more on audits, refer to Chapter 18.)

CEOs get better rises

From the summer of 2005 to the summer of 2006 average CEO remuneration packages increased by 28 per cent. This compares with inflation running at 2.8 per cent. This increase is also well above average wage increases across the whole economy which stood at 4 per cent. Despite this the chairman of one FTSE 100 company simply brushed aside concerns over soaring directors’ pay saying that annual rises in excess of inflation are ‘simply a fact of corporate life’.

Executive pay has become a significant issue as a result of this and other statistics. Indeed shareholders revolted over the pay package that GlaxoSmithKline proposed for its senior executives. Another primary concern is when the company underperforms and the CEO is forced to resign but walks away with massive payments received under their contractual arrangements.

For these and other reasons shareholders owe it to themselves, and each other, to take an interest and, if possible, attend companies’ annual general meetings.

Speaking Out at Meetings: Proxy Votes

Shareholders can voice their opinions during any type of meeting called by the board of directors to address a specific issue. At these meetings, shareholders cast weighted votes based on the number of shares they hold. These weighted votes are called proxy votes. If board members aren’t responsive to shareholder concerns on any of the issues in the list in the preceding section ‘Checking Out How the Board Runs the Company’, they might find themselves defending a major challenge at the annual general meeting.

Prior to the Enron scandal, a shareholder rarely brought forth an issue for the rest of the shareholders to vote on; usually, the company’s board of directors controlled what the shareholders voted on. If a shareholder issue even made it to the point of being voted on by the other shareholders, it rarely had a chance of passing. Today, shareholders are more successful at getting issues on the agenda to be voted on at an annual general meeting; sometimes, they win the proxy vote, and sometimes, they lose.

A proxy fight can cost a corporation millions of pounds no matter who wins; the preparation and mailing of the opposing arguments costs money and some of these battles go on for months and even years.

Hewlett-Packard’s costly clash

Walter Hewlett, son of one of the co-founders of Hewlett-Packard, led one of the most costly battles with a CEO and a board of directors when he tried to stop a merger with Compaq. Hewlett lost the fight with the CEO and the board of directors when the final vote of the shareholders ended in approving the merger.

Hewlett reported that he spent $32 million on his attempt to stop the merger. Financial analysts speculated that Hewlett-Packard’s board of directors, led by CEO Carly Fiorina, spent at least twice that amount on advertising in the major media markets where most of Hewlett-Packard’s shareholders lived, plus on other actions, to defend its merger decision.

In addition to the costly advertising, Hewlett-Packard’s board racked up about $70 million in expenses to defend its merger decision, including an estimated $3 million to individually call its shareholders and another $25 million in mailings to its shareholders. Hewlett-Packard also paid $33.5 million to investment banker Goldman Sachs, which handled the merger deal. Analysts guesstimate that Hewlett-Packard’s total cost for this fiasco was $100 to $125 million, and a good portion of that money was necessary only because of the shareholder battle.

Moving away from battling it out

Since the success of a number of shareholder fights, companies have been finding ways to negotiate with unhappy shareholders rather than fight it out in a proxy vote.

To avoid a costly proxy fight, boards of directors negotiate with unhappy shareholders, normally large institutional investors, by meeting with them quietly behind closed doors and discussing the issues upon which they disagree, with the hope that they can find a solution that both sides can accept. If the shareholders and the board of directors fail to find common ground, a proxy fight is likely. Knowing that a proxy fight can cost millions, more corporations are wising up to the fact that they should listen to their shareholders.

Major leaders of proxy fights are large institutional shareholders, along with the help of pension funds and some mutual funds. These large institutional investors hold large blocks of shares in their pension or mutual-fund portfolios, so they have a lot to lose if a company doesn’t do what they believe it should do.

Many times, the issues include the way in which the board of directors operates and how many independent directors will serve on the board and its various committees. The committee these groups are most concerned about is the audit committee. Shareholder groups want the audit committee to be made up primarily of independent board members to be sure that the audits are done in their best interests and not the best interests of the company insiders.

Sorting through reports and proxy votes

Sending out reports on an annual and biannual basis is the primary way a corporation informs its shareholders about its performance. Usually, the corporation sends the annual report before the annual general meeting along with information on the votes that will take place at the meeting. Proxy information is a critical part of the annual report package sent to investors. Voting by proxy is the primary way shareholders get to voice their position on board decisions.

The communication includes information about proxy votes, along with the board of directors’ position on any issues that will be presented at the annual general meeting. If the board brings an issue to the shareholders for a vote, the board explains the issue and its position. If a group other than the board brings the issue to the shareholders, the board states the issue and discusses why it’s in favour of, or opposed to, the issue. In most cases, the board opposes issues brought by outside sources.

The group bringing the issue to the shareholders, or opposing an issue that the board decided to bring to the shareholders, is also likely to send out its position to the shareholders. In fact, Walter Hewlett spent about $15 million mailing information to Hewlett-Packard shareholders in an attempt to stop the merger with Compaq, which we discuss in the sidebar ‘Hewlett-Packard’s costly clash’.

Catching Up on Corporate Actions

Corporations must report special events to their shareholders as soon as the event can materially impact (affect the profits or losses of a company) the results of the company. The most common special events might include:

Acquisitions: Before a company can finalise plans to acquire another company, it must report those plans to its shareholders.

Class-action lawsuits: If a company is the defendant in a class-action lawsuit that can have a material impact on its results in the future, the company must report the lawsuit and discuss its potential impact with company shareholders.

Mergers: If two companies plan on merging, the companies’ management must not only inform their shareholders but also ask their shareholders to vote on the merger. If the shareholders in either company vote against the merger, the deal will probably be cancelled. Sometimes companies may revise the deal and attempt a second shareholder vote.

Dividends: Whenever the board decides to pay dividends, it has to report that information to the shareholders. Of course, dividends are one of the few things that boards enjoy reporting, so they usually make a very public announcement about it to shareholders.

Bonus issue: A bonus issue or share split is when the board decides to make one share worth more than one share. For example, a bonus issue may be two shares for one, which means that each shareholder gets two shares for each share that they hold. Usually a company announces a bonus issue when it believes the price of its share is too high for the market. So a share that sells for £10 before a two-for-one share split will sell for £5 a share after the split.

In short, a company must give its shareholders the low-down on anything that materially impacts the value of the company.

Buying shares carries risk

As a client of a stockbroker you can use what is known as an execution only service. This is the cheapest way of using stockbrokers since they merely process the transaction you request, and have no part in advising you which shares you should buy or sell.

Alternatively you can ask the stockbroker for its advisory service and they will make recommendations for you to follow or reject. They do this, of course, for a fee.

Another possibility is to choose to have the stockbroker run the whole portfolio and then you have no part in the decision making process at all. This tends to be the most expensive way of operating.

If you decide to deal through Independent Financial Advisors, choose them carefully. Make sure they have experience of people who are seeking the same kind of advice as you are: it’s an extremely difficult choice and personal recommendation from a friend or family member may be the best way to go. Make sure also that they go through the proper procedures before selling you a product. Once again you can agree that they should advise you and make recommendations or merely show you their products. To do this they need to do an extensive fact find to understand the detail of your financial position and needs. Don’t forget that in all circumstances the IFAs have to make a living, by you paying them a fee or by taking commissions on the products they sell you from the insurance company or other provider. This potential commission gives them an unhealthy bias towards recommending those products that make them the most money.

Staying Up-to-Date Using Company Web Sites

The Internet provides an excellent way for companies to stay in touch with their investors. Companies can include an unlimited number of pages on Web sites that investors can access whenever it’s convenient for them. Because investors can print multiple copies of the information provided online for free, the company doesn’t have to worry about the expenses of providing thousands of pages of information to its investors.

In addition to basic information – such as company headquarters, addresses, phone numbers, and key executives – many companies post their company’s history, market share, vision and mission statements, credit ratings, and share dividend history. In addition, many companies post all the information from their annual general meetings and financial reports, as well as press releases and key executives’ speeches. So the Internet is a handy tool that gives investors greater access to company activities and helps the company keep its investors better informed – which improves the company’s long-term relations with its investors.

After reading the information provided, investors who have a question can find information about who to contact and how to contact the company by phone, Internet chat room, or e-mail. On many company Web sites, investors can also order paper copies of previous annual and biannual reports that are up to five years old.