My second principle under Management Ethics is ” be clear, open and honest in our communications with investors“. A sub-bullet of principle #2 is “financial performance should be tracked and reported in a clear and unbiased way“.
It might seem odd that this is embedded in an ethics principle. Is it not commonplace that companies follow this principle, as every company has to abide by GAAP?
In the early 2000′s, Enron and Worldcom collapsed. These companies followed GAAP. In fact, they “knew” GAAP so well that they found ways to use GAAP to deceive their investors. Were they clear with their financials? Were they unbiased? With the benefit of hindsight, the obvious answers are shouts of No and No.
Sarbanes-Oxley, also called SOX, was to fix this. Did it? My less-than-educated guess is that it helped a fair amount. However, the Great Recession of the late 2000s provides plenty of examples of public companies who were anything but clear and unbiased in their reporting to shareholders. Plenty of SOX-compliant public companies were culprits in the housing crises.
SOX, by holding CEOs and directors personally liable for bad deeds, has inspired many companies to simply cut back on their public reporting. They comply with SOX, but they do so with providing the minimum required information. As a CEO of a company with public debt, I understand where these companies are coming from. It is very demanding to meet SOX compliance. Even if intentions are noble, legal exposure is a very-real risk to companies, individual directors, the CFO, and the CEO.
I view SOX as having raised the expectations for minimum information to be reported and as raising the stakes for failing to comply. However, simply complying with SOX does not mean that my Management Ethics Principle 2 is satisfied. To understand why, let’s focus on the word “Performance”. Why was “Performance” used instead the word “Results”? There is a subtle but important difference. Results implies a backward-looking activity. What did the company accomplish last quarter or last year? GAAP, by the way, is all about how to account for past results.
“Performance” implies more real time. How is the company performing? It is a continuum of what results were posted in prior quarters as well as the leading indicators that foreshadow what to expect in future quarters. Leading indicators are metrics such as Gross New Sales (“Bookings”), quality of the Bookings such as capital intensity, Churn, Revenue under Contract, and Pricing Trends. All of these are non-GAAP terms, but are extremely helpful to an investor whose goal it is to gain insight into future financial results.
Many companies provide leading indicators, but they do so in an inconsistent or unclear fashion. For example, they might share some metrics in certain quarters, but different ones in other quarters. Is it shocking that the ones they choose to share are favorable in the quarter they share them? I strive to share a robust set of consistent metrics, so that insight can be gained on both positive and negative leading indicators. Moreover, I share the data for prior quarters alongside the most recent quarterly data–so that it is easier for investors to see trends. When I review the data with prospective investors, I focus equally on positive, neutral, and negative trends. I try to refrain from using positively-biased adjectives. I prefer to let the data do the talking.
It is management’s responsibility to be clear, open and honest when communicating with existing and prospective investors. To accomplish this, financial performance should be tracked and reported in a clear and unbiased way. Management should make it easier for investors to understand financial performance and trends. The reward is that investors will buy and sell at prices that are better informed by company results. The transparency also removes uncertainty, which means investors will apply lower discount rates when determining the value of the company. This too leads to a fairer outcome for both new and exiting investors.
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