Mark Hynes - thoughts on corporate disclosure

Opinions on changing rules, changing best practices, and their effect on investor relations officers.

Monday, November 27, 2006

Heavyweights zero in on Sarbanes reforms.

There is an interesting convergence of themes on whether regulators in the US will react to the changing decisions of companies seeking to list. In the blue corner, arguing for a more “agile framework” is Mr Paulson, USA Treasury Secretary. In the red corner, Mr Eliot Spitzer, denying that US rules are hurting US competitiveness.

The London Stock Exchange has seen a flood of new companies joining the market that otherwise might have preferred Wall St, such as the vast Rosneft and Kazakhmys and the 36 Chinese companies now listed on Aim. Twice as much foreign equity is now traded in London as in the US.

Paul Sarbanes and Michael Oxley were lauded as heroes, whose rules would clean up corporate America. Four years on the view looks rather different. And the SEC is under pressure to relax some of the more demanding aspects of SOX.

A few weeks ago, US treasury secretary Henry Paulson, favoured a study aimed at determining how much America is losing out as a result of the stringent internal compliance and audit rules, which include a demand that chief executives personally declare their annual figures to be true.

Mr Paulson – and others – fear that US public markets are losing out to foreign rivals and private markets, ie that companies prefer to list on non-US markets or move into private hands rather than play by US rules. Chief executives’ estimates of annual SOX compliance range from £15-20 million pounds.

And with the strong potential for US exchanges NYSE and NASDAQ acquiring and merging with LSE and Euronext, many are concerned at the prospect of US regulation by the back door.

All of which puts into context the remarks made by Mr Eliot Spitzer, noted for his aggressive actions against investment banks and others during his time as New York state's attorney-general. Now fresh from winning the New York governor's race by a landslide, Spitzer has defended SOX. In an FT interview, he noted "The argument that we are failing in competitiveness because of regulations is incomplete. We're failing in competitiveness because of failed business models and the lack of smart investment in technology.”

This argument could run and run; meanwhile don’t expect a relaxation of the Sarbanes Oxley requirements anytime soon.

Thursday, November 16, 2006

“Good disclosure reduces the cost capital”. Old chestnut? Not any more

It is a perennial question; does offering excellent disclosure have a positive effect on companies’ cost of capital? Despite the fact that regulators often use that as a supporting reason for imposing new obligations companies, there has been little supporting evidence. In the aftermath of the corporate crises of the last few years, regulators – in imposing the raft of new regulations from the Market Abuse Directive to Transparency Directive and the new disclosure rules across Europe and the US - have argued that they are assisting companies’ performance through this new regulation.

Although a link between strict disclosure regulation and firms’ cost of capital seems intuitive, there has been little empirical research showing the benefits of disclosure regulation and increased transparency.

In the study “International Differences in the Cost of Equity Capital: Do Legal Institutions and Securities Regulation Matter?”, University of Chicago Graduate School of Business visiting professor Christian Leuz and Luzi Hail of the University of Pennsylvania’s Wharton School address this gap, investigating whether stricter disclosure regulation and stronger legal (and institutional) infrastructures offer tangible benefits to firms in 40 countries. The authors analysed differences in the cost of equity capital for these countries, with “equity capital” defined as the money invested by shareholders of the firm.

Leuz and Hail estimated the cost of capital from 1992 to 2001 for several thousand firms from 40 countries. The study is the first to analyse international cost of capital differences for such a large number of countries and to link them with cross-country differences in regulation mandating and enforcing corporate disclosure.

The authors found that firms from countries with more extensive disclosure requirements, stronger securities regulation, and stricter enforcement mechanisms have a significantly lower cost of capital. They established that the cost of capital of firms in countries whose securities regulation ranks in lowest quarter can be as much as 2 percentage points higher than the cost of capital of firms in countries whose securities regulation ranks in the top quartile.

So all that work by IR professionals and the investment in good disclosure systems seems to be very worthwhile…

Thursday, November 09, 2006

A bad idea for issuers and for investors.

First a disclosure. As noted in my personal details, even though this is a personal blog, I work for PR Newswire, a news dissemination company. Now the bad idea.

A couple of weeks ago, the CEO of Sun Microsystems, Jonathan Schwartz, posted on his blog the view that web posting should suffice for meeting transparency obligations of listed companies. This week, the notion has been rebutted by no lesser person than SEC Chairman Christopher Cox, although in his reply, Mr Cox leaves the door open for further discussion.

This idea surfaces every now and again. Something similar was proposed back in 1999 by Commissioner Unger. It was subsequently dropped as being unworkable. Again in 2002, the European Commission in a consultation on what was to become the Transparency Obligations Directive, proposed it again. It was once again shown to be unworkable, and replaced with the tried and tested option of properly distributed press releases serving the financial services community best.

Why has the concept been found wanting? Here are 10 reasons.

1. Push versus pull. A posting on a website requires investors to proactively set up to receive the information. This has consequences such as the institutional market (with greater resources to do this) being better informed than retail, creating selective disclosure.

2. Formatting. No matter what format is loaded on to the website, it will inconvenience some part of the media and delivery chain, reducing the visibility of news in the multitudes of media. The equity terminals are notoriously inflexible in catching news from multiple, random sources. Reuters et al are highly unlikely to redesign their entire editorial processes to accommodate this notion.

3. Validation/ editorial checking. There is well-substantiated evidence that show the number of occasions on which a release - fully approved by the company - has mistakes. 3rd party eyes and ears can help ensure that incorrect information does not reach the markets.

4. Security of posting. Is the person posting the release on the issuer's website entitled to do so? Would every company have to create restricted zones for IR, corporate secretary etc?

5. Role of financial PR companies. Financial PR companies post large numbers of results releases to the newswires. Would every company expect to give the PR companies access to the (secure) area of their website?

6. Down time. No single source can be relied upon 100% - the newswires have (had to) invest in redundancy of systems, ensuring permanent access. Not every company will have the resources to do this, and smaller caps are especially vulnerable.

7. Access to the 'editorial process'. Journalists work in many different ways, some on email, some using newswires, some on fax etc, with a constantly moving population. It is unreasonable to expect all companies to keep up to date with journalist changes, or to develop multiple mechanisms to deliver to these different audiences. And expecting investors and journalists to re-register is frankly unrealistic.

8. New media types are constantly emerging - it is in the commercial interests of the newswire to constantly patrol for these media, and harness them. Would all quoted companies be as diligent?

9. Simultaneity. The principles of good disclosure - never mind the law of the land - requires news to be accessible to all investors at the same time. This would be impossible for companies to achieve.

10. These challenges will inevitably hurt smaller companies most, a) by increasing cost to enhance their websites to the necessary degree, and b) investors will access large companies first; an investment story from a smaller company will win less prominence, ultimately strangling some prematurely, due to less access to capital.

OK rant over.