TRUTH AND CONSEQUENCES
How CFOs can raise their corporate integrity through improved investor relations.
By Abe De Ramos

Marc Faber has an unconventional investment strategy. Instead of poring over income statements and scheduling meetings with executives, he prefers speaking to competitors of companies he's considering investing in. "I don't care so much about what the company is saying. I'm going to find out from its competitors, suppliers and customers what they think of that company," says the regional investment advisor. To Faber - who has a reputation for pessimism - the reason is simple: CFOs are incapable of shooting straight from the shoulder. "You'd be out of your mind if you thought they would tell you anything close to the truth."

It's an extreme generalization, but who can blame him? Yes, there is greater demand for transparency since the spate of corporate scandals in the US. However, it has largely bypassed Asia where many local companies have little or no history of keeping an open-book policy for the investing community. Analysts and investors, including those from major research and investment management houses, are hard-pressed to win an audience with a CFO, even during earnings announcement periods. And when they do, they complain that the amount and quality of information they get hardly enables them to make confident decisions.

In truth, there is a huge gap between the level and quality of information that finance chiefs are prepared to give and the information the investing community thinks it should get. And that gap undermines one of the most important CFO functions - investor relations. Addressing investors' concerns is vital, especially at a time when uncertainties abound. After all, CFOs prepare the financial statements upon which directors act to determine the course of the company. As Peter Tse, CFO of Hong Kong electricity provider CLP Holdings, puts it: "A financial report reflects the integrity of the board, and the CFO is an important part of it."

In the relatively new world of good corporate governance in Asia, however, the art of transparency and disclosure has yet to be perfected. Given such circumstances, the results of CFO Asia's second Best Annual Reports survey, done in partnership with Belgium-based reports evaluator Enterprise.com, part of US-based Corporate Essentials, is hardly surprising. Of the 144 companies that participated in the survey, only 40 achieved half the maximum score, reflecting the results last year (see survey results).

Since the corporate scandals of more than a year ago, the quality and quantity of information in the latest annual reports survey has improved, especially in operations reports and corporate governance structures (notably Thai companies), says Mike Guillaume, manager of Enterprise. But for the majority of reports, executive statements ranged from weak or evasive, to insubstantial or "plainly boastful". Financial reviews were short, hollow and superficial, while information on the financial performance of business segments was inconsistent or incomplete (especially Japanese companies). Save for a handful of reports, risk analyses were almost non-existent (see box, "Hits and Misses").

Fighting Talk

Compounding this lack of transparency on paper is an investor communications policy that leaves much to be desired. Comments like the following regularly turn up in analyst research reports: "Lack of management comments in the results announcement increased earnings uncertainty: we have cut our net margin assumptions." But even this is not strong enough to elicit a reaction from CFOs.

In what has become a vicious cycle, company executives would only come clean if their lack of transparency had aroused suspicions that affected their stock price. In the first two weeks of February 2003, for instance, three major Hong Kong companies denied market-moving speculations that could have been prevented if guidance was given sooner. Sun Hung Kai Properties, a major developer, denied that sales of a new office building were slow. Great Eagle Holdings dismissed rumors it would issue shares to fund an ongoing property project. Then telephone firm PCCW clarified conflicting reports about its bid to take over British telecoms provider Cable & Wireless.

These made all-too-familiar headlines in Asian business pages. Surely, analysts and CFOs - using the press as a conduit - must be getting tired of this game of speculation and denial? But arguably, it is the direct result of a lack of transparency among Asian companies, which in turn is a reflection of their poor corporate governance. In an age when investors need better guidance, silence is a losing battle. "The more disclosure the better; that's part of being a public company," says Charles Hill, research director at Thomson Financial/First Call, which publishes analyst consensus estimates on companies globally. "Let investors and analysts decide."

As regulators become stricter, CFOs may not have any choice but to disclose more, and more often. But where should they begin? In a survey on corporate disclosure, the US-based Association for Investment Management and Research ranked the ten most important pieces of information that analysts and investors need to do their jobs well, but which are not disclosed fully by CFOs. The association's list includes information on business segments, forward-looking information such as strategic and business plans, off-balance sheet assets and liabilities and explanations of extraordinary charges.

Even in the US, where the Securities and Exchange Commission is tightening laws on greater disclosure, "CFOs are learning to follow the spirit of the law, and not just the letter of the law," says Hill. In the end, it's up to the individual CFOs, with the support of management and the board, to improve transparency. Says Sheree Tan, chief investment officer at Morley Fund Management in Singapore: "Is transparency just the provision of information required by law? The attitudes of companies need to change first in order for transparency to improve."

Law and Order

CFOs of companies that scored well in this survey can only agree. "No matter how many laws you put in place, you cannot legislate for integrity," says John Poon, CFO of Hong Kong-based clothing retailer Esprit Holdings. As Esprit has discovered, good governance, even in its most measurable forms - corporate reports and accessibility - has its rewards. For Tse of CLP Holdings, it reduces the volatility of the stock price, which eventually results in a cheaper cost of capital. For Poon, it has helped double Esprit's market capitalization in just three years.

Analysts and investors in a growth stock like the US$1.2 billion annual turnover clothing retailer (survey score: 3 stars) are more concerned about the company's outlook, and Poon is trying to turn giving the right information into a fine art. "People don't buy Esprit for dividends," he says. "People buy our stock for its growth and capital appreciation, so it's important for the investing public to get a good feel about where we're going." Before investors ask, Poon already has prepared answers for the following questions: Realistically, what can we accomplish in the foreseeable future? How much capital do we have to commit to get there? And what are the risks associated with that?

They all sound so simple, yet in practice, these questions hardly ever get answers. In a classic case, Chartered Semiconductor (survey score: 1 star), a Singaporean chipmaker, told analysts late last year that it had no immediate need for cash. But only a week later, the company surprised the market by announcing a rights issue, sending signals of financial desperation. Investors panicked, and Chartered's market capitalization halved almost overnight. Even now, analysts have yet to find any logic in the move. Some have speculated that the company might eventually be bought entirely by the government, its majority shareholder.

One common reason CFOs give for choosing to be opaque about future strategies is to protect themselves from having the rug pulled from under them by competitors. But Robert Eccles, a financial advisor and co-author of the book Building Public Trust, says: "The whole thing of providing 'competitive information' is mostly a red herring. It's an excuse, not a reason." He adds: "Companies typically know things about their competitors that they don't think their competitors know about them. More and more information is available in various ways, so you might as well report it yourself and make sure it's accurate."

While Poon acknowledges that investors' demand for detail is insatiable, he also tries to set his limits. "You don't have to come up with a business plan with all the financial numbers put into the prospect," he explains, "but investors would benefit from our thoughts. Do we want Esprit to be a single brand business for the next two years because our capital and human resources are already fully committed, or do we think the group would be better served by complementing its growth with acquisitions?" What CFOs want to avoid, he says, is to over-commit themselves with goals they may have to backtrack on. "You don't have to talk about execution, but you can talk about strategy."

So far, he has measured his limits correctly. Analysts praise Poon for knowing what matters to them, and some are more than satisfied with his disclosure practices. "We generally just want an outlook," says Ada Poon (no relation) of UBS in Hong Kong. "Do they guide you in terms of outlook, and does it turn out that way? Have they told you something, but it's turned out not to be the case? Of course, they can change the plan, but do they tell you about it?"

As analysts would confirm, few CFOs would go out of their way to explain an intriguing situation. But Poon, who joined Esprit in December 1999, has been actively engaging analysts and investors in dialogue. He claims that he has not turned down a single request for an analyst or investor meeting. "When John came along, one of the things he did differently is that he would read analysts' reports and call us and try to understand from us what our view was, where we were coming from," says Poon of UBS. "He would then explain to us his side."

This active engagement has no doubt helped Esprit's management in improving its position in the market. The company's average daily trading volume has multiplied sixfold in three years, while its market capitalization has doubled to US$2.5 billion as of mid-February. This, eventually, led to its inclusion in the Hang Seng Index last December.

Let the Light In

At CLP Holdings (survey score: 3.5 stars), the entrenched utility has long acknowledged its limited growth prospects in Hong Kong - a minuscule 2-3 percent annual revenue growth - and has consequently set its sights on China, India, and Australia. Because building power plants is a long-term business that takes up to 15 years before generating returns, CFO Peter Tse keeps investors interested by highlighting the risks of overseas businesses, and how those risks are addressed operationally, through frequent investor communications - in person, in financial reports, and on CLP's website.

For example, analysts have outlined the following as the risks in investing in CLP: that CLP has reached maximum demand and is facing downward tariff pressures in Hong Kong; the expiration of its Scheme of Control agreement with the government in 2008; competition from Chinese power companies; receivables in India; and pool prices in Australia. CLP addresses these in its Management Discussion and Analysis, in the "Frequently Asked Questions" section in its website, and in dialogues.

Financially, CLP reports the liabilities associated with its overseas investments beyond the requirement of Hong Kong accounting rules. The liabilities are summarized in a two-page illustrative section in its annual report called "Financial Obligations at a Glance", which consolidates its equity share in the liabilities of its subsidiaries, including those in which it has only a minority interest.
"Those liabilities are without recourse to CLP so we do not consolidate them [in the group balance sheet]," says Tse. "But by presenting them in two pages to shareholders, people can make a better evaluation of CLP." This presentation is unique. Most financial reports - globally - bury contingent liabilities in the notes to the accounts. That is, if they mention them at all.

"CLP's 'At a Glance' is an intelligible and communicative way of explaining the interactions between the statements, with some key notes to them," says Guillaume, who calls the section a benchmark. "It puts results and amounts in perspective and gives the ideal picture to kick off the reading of a financial review, especially for the shareholder unaware of basic financial mechanisms, which is, lest we forget, the case with most of them." Simple, that is, but not simplistic. In its ranking of annual reports globally, Enterprise gives CLP a high rating of B-plus, on a par with General Electric.

For Tse, the rewards of transparency can be measured numerically, not from its quoted share price, but from its beta - a measure of the volatility of the share price over a given period of time. Because beta is a multiplier in the calculation of a company's cost of capital, a low beta means Tse can better tame or manage the cost of running his capital-intensive business. Tse estimates CLP's 12-month beta at 0.6, one of the lowest in Hong Kong, and among utility companies globally.

"By improving the communication process between the market and the company, even if there is a short-term misunderstanding, it can be rectified right away," says Tse. "I'm not saying that an increase in transparency will directly help the share price, but being transparent, being predictable, will reduce the beta, which is one of the ways we can reduce the overall cost of capital of the company."

Feedback Value

Kuah Boon Wee, CFO of Singapore-based defense engineering contractor ST Engineering, takes investor views so seriously that he has devised a simple, yet innovative, way of getting them: ST attaches feedback forms in its reports and website, which investors fill in conscientiously.

The result is an annual report (survey score: 3.5 stars) that gives more information than those of its peers. Consider this: in its annual report and investor meetings, ST announces its economic value added (EVA), a measure of returns after deducting cost of capital. "[In the feedback forms] people will ask a lot of questions on certain areas, and you realize it's an area of interest," says Kuah.
But Kuah is even prouder of the fact that he discloses ST's order book, or the status of new and existing orders. He considers this a way of explaining the long cycle time involved in building defense-related vehicles and equipment. "We disclose that information every quarter so people have a good grasp of what our position is - between new orders, and sales from existing orders," he says.

ST's report on the performance of its four business segments is also not limited to revenue contribution, as is commonly the case in most reports. Its segment reports include a full set of financials, from profit and loss accounts to individual cash flow and balance sheet statements. "We don't do all the notes when it comes to the annual report, but [with these details in segment reporting] you pretty much get a complete management discussion on what affected the business in the period concerned," Kuah says.

His compatriot, Teoh Tee Hooi, CFO of Singapore Airlines (survey score: 3 stars) backs him up on disclosing more than is required by law. "Access to historical performance as well as forward-looking information on trends, opportunities and risks, help investors and analysts make informed decisions about us," says Teoh. "Proactively engaging stakeholders in two-way communication helps us gain valuable feedback about our operations, and puts us in a better position to address any concerns."

For Kuah, investor relations and preparing financial reports is all about pre-empting investor concerns. "It's a case of thinking: 'How do we explain our business to people, who may not be as familiar with our business?'" he says. With attitudes like this, it's only a matter of time before the Marc Fabers of the world put a little more trust in CFOs.

Click here for full results in pdf format

Additional research by Vero Escarmelle of Enterprise.com.