Investor Relations (IR) can be even more important to a company’s stock price than good corporate governance. That is especially true in Emerging Markets (EMs).
A few academic researchers have set out to see if better, more active Investor Relations efforts result in higher stock prices. And, yes, they do: one standard deviation increase in IR score is associated with an 11% increase in Tobin’s Q (a stock price proxy) while good governance is associated with a 9% rise, according to one important global review. This comports with finance theory that assumes a commitment to better disclosure should lower information asymmetry and thus should lower cost of capital.
The most important component of IR efforts appears to be what researchers call “Global Outreach.” This entails engagement with brokers and sell-side analysts, attendance at conferences, and one-on-one meetings between company management and investors. They find Investor Days are the best way to control messaging. The large majority of firms surveyed held Investor Days at least once a year. Cartica has a portfolio company that successfully held four Investor Days in 2021, each focused on a different business segment.
Even though the studies use old data (because academic work is slow), ESG is one of the fastest growing area of attention. 82% of the IR officers (IROs) surveyed mention that communicating on governance is a part of their job. “IR Update” magazine has noted that the majority of shareholder proposals are related to governance issues. Surveys mention that it is investor demand that is pushing ESG disclosures.
How does IR translate into better stock prices and lower cost of capital?
A few studies cite the 1) increase in the number of analysts following the stock, 2) more accurate forecasting by sell-side analysts, and 3) less dispersion among the sell-side forecasts as the specific channels through which good IR translates to higher stock values. But beware, one older study showed that IROs who got better ratings by IR magazines had all the analysts marching to the same tune … but the analysts were not necessarily more accurate in their EPS forecasts. Luckily for IR, newer studies are kinder: they find that analysts’ forecasts are more accurate when IR is more active.
The most important activities for realizing the stock price benefits of IR appear to be (1) broker engagement via sponsored conferences, (2) interactions with investors, e.g., meetings with the CEO/CFO, (3) regular engagements with global institutional investors.
Does it matter where the firm is located?
The largest study we found shows that better IR is more critical in Emerging Markets, specifically in countries with lower accounting standards quality, looser regulation, less enforcement around self-dealing and insider trading, and overall less reliable rule of law. This makes a lot of sense to us, which is why Cartica, as an EM investor, is a champion of good IR.
In addition, firms engage in more IR activity when they are further away from foreign institutional investors.
Is IR mostly just hype?
Researchers also examine exaggerated claims by IR, choreographing of earnings calls (for example, by recognizing the friendliest analysts in the Q&A), and media spin (more coverage of good news than of bad news). While spin can temporarily increase stock prices, it results in negative future earnings surprises, more earnings restatements, higher accruals, more insider selling, and overall lower return performance. In the end, honesty is a better strategy than hype! This is great news for investors and firms alike.
IR is part of brand building, reputation recognition, corporate social responsibility, and stakeholder relations. How a company’s IRO acts can reflect on the perceived quality of management.
Does the research say anything else that is useful?
One study shows that experience matters. When a firm switches IROs, analyst forecasts become less accurate and more widely varying, and the price discovery process slows. So, this may be good news for seasoned IROs already doing a good job.
Another study shows that better IR is associated with lower bid-ask spreads and more liquidity, though there is some disagreement on this. At Cartica, we often encourage better IR for companies that suffer from lower liquidity, because our own experience has been that good IR does help with liquidity.
Considering and communicating non-financial factors not only enhances the investor experience but also improves financial communications. As per our November ESG Quick Take, Cartica is always trying to assess the quality of management. So, these non-financial disclosures are extremely important to us and other investors.
Cartica's advice
Cartica seeks to develop relationships with our portfolio companies over time, and IR is often our first and most regular point of communication. Excellent IR teams leave investors with more confidence in the perceived quality of management, and negative interactions with IR can leave a lasting bad impression.
Given that IR may be as critical as corporate governance, Cartica encourages our portfolio companies to hire dedicated IR staff and to consider hiring dedicated ESG staff who can engage with investors on ESG issues that are material to the company. We appreciate it when IR is English-speaking, accessible, responsive, direct in answering questions, and open to investor feedback and suggestions.
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