The Ghost in the Capital Markets Machine

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“All money is a matter of belief.”

-Adam Smith, 1776, Scottish Philosopher and Economist, author of The Wealth of Nations

“Reality is that which, when you stop believing in it, doesn’t go away.”

-Philip K. Dick, 1978, member of the Science Fiction Hall of Fame

“Investing is the intersection of economics and psychology.” 

-Seth Klarman, 2011, famed value investor and founder of the Baupost Group

The quotes above, from different ages and perspectives, each highlight some basic truths, and together, the reason capital markets remain as unpredictable and mysterious in the 21st century as they were when 13 American colonies were just declaring independence from England. As we await the next major capital markets crisis that no one can predict – while everyone tries – the market’s known unknowns (and permutations thereof) will persist for as long as human decision-making drives investing. IROs manage hundreds of high touch, high intensity human relationships, often thousands, portfolio managers, buy- and sell-side analysts, investment professionals whose collective decisions comprise the equity market that ultimately drives the IRO’s company’s value premium, or discount. Increasingly, the mood of this collective consciousness is critical to the job security of the IRO’s management team and can even affect perceptions of the company’s product or service brand in the commercial marketplace.

Market Mind Reading in One Step, or Ten

With the complex and shifting environment IR teams are expected to manage it may seem far-fetched to expect IROs to make step changes in their capital markets communications capabilities. However, by applying to IR well established know-how that is best practice in most other competitive marketing practices, the IRO will lead more successful program outcomes and manage capital markets more effectively. Behavioral economics, which spawned behavioral finance, can enrich your capital markets communications. Reading even one of my top-ten behavioral economics books listed below (in alphabetical order), and noting the ways it applies to IR’s capital markets goals will provide meaningful professional returns.

Time is More Valuable than Money

Senior management time is by far the most valuable – and too often most wasted – investment in corporate IR programming. The returns on this investment, and measuring the capital markets rewards of risking management’s time, remain alien to most IROs and senior management teams alike. The frustration factor on both sides is relatively high as well.  We’ve all been there when the CEO opines about a meeting with a portfolio manager being a “waste of time” because the portfolio manager’s focus seemed diffuse, or that the line of questioning followed topics very different than other meetings on the trip, or because the CEO thinks a string of negative questions from a potential investor means they have negative views about the stock’s investment potential. If you ask for their reasoning, you’ll rarely hear an analysis based on more than the content of the questions and answers in the meeting itself, colored more often than not by the mood of the CEO at that moment. Most IROs know that there are reasons their grumpy CEO is incorrect but are unable to call upon explanations and analysis that will either inform or satisfy their senior colleague, so they wait for the dark clouds to pass, feedback calls to be completed, and all parties turn a blind eye to the clear signs telling them “there must be a better way.”

Is MiFID II a Cure for Willful Blindness?

Today, senior management know less about their investors’ thought processes (“passive” investors included) than any other of their key stakeholder groups. This despite job tenure dependent on investor sentiment, a gnawing fear of activist investor uprisings, and professional reputation tied more closely than ever to share price performance. The amounts that my clients’ management teams know about their customers’ mindset and decision-making process is amazing, and somewhat unsettling when they’re talking about consumers like me. It’s almost as if they can read my mind because of the resources their business has invested in competing most effectively for a share of my wallet. When it comes to institutional investors and their “shareholder demographic,” it’s willful blindness as opposed to the finely trained intellect and critical analysis applied to their other key stakeholders.

For decades, senior management has been lulled into complacency by the “free IR” of sell-side corporate access. However, front page coverage in the FT, WSJ, et al, of the corporate access related components addressed by MiFID II could lead senior management to finally face the reality that properly resourcing professional management of their capital markets communications and investor relations is a necessity. But, the ability to ignore the obvious is hard wired into humans (see no. 9 below) and senior management have been encouraged to ignore glaring management-investor market dysfunctions for over 20 years now. Sometime in 2018 we’ll know whether MiFID II has disrupted the status quo enough for senior management to see the light and accept that the capital markets are as mission critical as their commercial markets – and react accordingly by properly resourcing their IR function.  In the meantime, IROs can invest some of their own time to be better prepared for any capital markets scenario in 2018 and beyond.

Whether You Call it Behavioral Finance or Behavioral IR, It’s Low Hanging Fruit for the IRO

While it’s unfortunate that IR is well behind every other professional marketing practice in terms of applying major advances in behavioral economics, social psychology and neuroscience, since much of it has already been “mainstreamed” it means that there is an easily accessible body of knowledge for IROs to gain from, virtually all of it combining intellectual rigor with common sense. 

Reading and taking notes on what are substantial books is doable for most anyone with as much airplane and airport time as IROs. And if you think I’m trying to present myself as a scholar, please note that about half are “New York Times Best Sellers,” and you’ll probably recognize most of the authors’ names. If your colleagues ask where you learned your new IR know-how and scientific insight into investors’ motivations and decision making, tell them a Nobel Laureate taught you. As I write this, the third Nobel Prize in 15 years has been awarded to one of the field’s leading thinkers, Richard Thaler, who is highlighted below along with the other two Nobel Laureate authors, Daniel Kahneman and Robert Schiller.

1) Animal Spirits, by George Akerlof and Robert Shiller

  • Summary: An examination of the animating market force hiding in plain sight – human psychology – one that drives the capitalist economy, most dramatically clear in capital markets bubbles and crashes, but an influence on every trade in the equity market every day.
  • IR Insights: A compelling refutation of the rational investor/efficient markets thinking that too many corporate leaders use to justify underinvestment in capital markets communications and investor relations.

2) The Decision to Trust, by Robert F. Hurley

  • Summary: A book structured mainly around corporate leaders building trust within their organizations; replacing references to “employees” with “investors” transforms this into a “how-to” guide for developing a supportive institutional shareholder base.
  • IR Insights: Hurley’s ten-point checklist of “Practical Ways to Build Trust” is especially useful for IROs working to build a shareholder base across physical and cultural borders, and there are numerous similar constructs laid out for the reader.

3) The Invisible Gorilla: How Our Intuitions Deceive Us, by Chris Chabris and Daniel Simons

  • Summary: Discussed in my blog The 800 Pound Gorilla Runs Speed Dating IR, this book drives home that even professionals with the best intentions (e.g. institutional investors) are unable to remember and process major elements of any event. “Inattentional blindness” was recently covered in The New York Times by Heather Murphy.
  • IR Insights: For IR, this highlights the need to repeat, restate and review an investment thesis for any investor audience, well beyond what seems to be considered current best practice when meeting investors. It also reinforces what IROs already know, if critical information is not communicated where investors expect to find it, even if it’s “there,” the company will be criticized for mismanaging expectations. I touched on this in my blog post entitled: Danger, Will Robinson! DANGER!

4) Nudge, by Richard Thaler and Cass Sunstein

  • Summary: This book dissects the biases and heuristics of investors as it highlights a wide range of economic decision-making scenarios.
  • IR Insights: IROs and their colleagues in senior management are some of the “public nudgers” or “choice architects” cited in this book, which is framed to help an individual to try to make better and more educated decisions. The book also highlights the reasons for the management-investor spiral into “short termism” that no one seems to publicly support, but most continue to reinforce.

5) Predictably Irrational, by Daniel Ariely

  • Summary: Putting rationality to the test, this book focuses on the systematic and predictable way people make decisions, which is inherently irrational in very many ways. Anyone who establishes an institution called “The Center for Advanced Hindsight” has a book that must be worth a read.
  • IR Insights: That capital markets communications remains built over the long term of rigorous reporting of facts, outcomes, financial results, etc., is the counterweight to the power of the irrational process of human decision making. Direct engagement with both components as they interact is the reason IROs have the potential to assume a leadership role in the capital markets. 

6) The Psychology of Risk, by Glynis Breakwell

  • Summary: This is the hardest read on the list (it’s a textbook after all); it has a number of practical checklists and dissects a concept fundamental to professional investing. If I’m honest, I skimmed it, but even an earnest skimming generated a great deal of compelling content.
  • IR Insights: The checklists and graphics in this book can help the IRO start to frame their own approach to consistently assessing the ways investors process the risk, and rewards, of investing in their company’s shares. 

7) Thinking, Fast and Slow, by Daniel Kahneman

  • Summary: This book breaks down the mind’s approach to decision making into System 1: quick, emotional, intuitive based decisions, and System 2: more thoughtful, deliberative and cautious decisions. Listening to a number of interviews with Kahneman reinforces the sense that not only are you learning from a Nobel Laureate, but a man who is also very caring and wise.
  • IR Insights: We are encouraged to think of professional investors (especially by professional investors themselves) as basing investment decisions almost entirely on System 2, but even if this were the case (it’s not), understanding System 1 is still critical to gaining the attention of existing and potential investors alike. And one only needs to read the sell-side reports of this era to spot the dominance of writing that tries to interpret as quickly as possible the “tone” of earnings calls, “shifts” in market sentiment, whether management was “upbeat” or “downbeat” during presentations at capital markets days, reflecting the System 1 of the capital market itself.  

8) Thinking Strategically, by Avinash Dixit and Barry Nalebuff

  • Summary: Marching through case studies from business, sports, entertainment, politics, and gambling as well as hostile M&A, the book outlines how to best manage decision-making towards consistent goals by applying what we know from game theory.  I discussed this in my blog: An Ultimatum to Unfairness.
  • IR Insights: Generally focused on successful negotiation and more generally managing organizations than in the context of applying strategy in a competitive environment, the book helps frame ways to both prioritize and gain more actionable insights from interactions with existing and potential investors. This book emphasizes why IROs should lean more on the relative luxury of the many aligned interests of management and shareholders.  After reading this book, which is built around mostly contentious and fiercely competitive scenarios, one more deeply understands why “distracting noise” best describes IR messaging not founded on or directly connected to management-investor shared goals.

9) Willful Blindness, by Margaret Heffernan

  • Summary: The book’s subtitle, “Why We Ignore the Obvious at Our Peril”, summarizes the book very well. I referred to this “willful blindness” in my blog: Danger, Will Robinson! DANGER!
  • IR Insights: In the capital markets, the interplay between an individual’s ability to ignore the obvious, and the reality of “herding”, “crowded trades”, as well as a stock’s value being set by perceptions, makes this both enlightening and perplexing. For the IRO, working with facts and outcomes in an environment of long term verifiability is the counterbalance to a number of humankind’s blind spots (as mentioned in book no. 5 above).  But if you don’t know, or acknowledge the scope of these blind spots, they can’t be addressed. 

10) Wrong, Why Experts Keep Failing Us, by David A. Freedman

  • Summary: Maybe the most topical book on the list in terms of today’s headlines (literally), Freedman discusses how today’s media has honed headlines to stimulate your limbic system (fear, lust, greed) and pick and choose from expert findings, just as experts pick and choose from data and results of studies to find the conclusion they want.
  • IR Insights: Most interesting to the IRO is Freedman’s practical advice on how to craft messaging and headlines that reflect the realities of attracting the brain’s attention while staying true to the facts and the content of the piece. IROs tend to be very skilled in this approach, and further insight into what’s happening in the brains of the investor audience will further hone this skill.

Any suggestions regarding books I’ve left off the list will be gratefully accepted, in the meantime, enjoy the learning.

“The more original a discovery, the more obvious it seems afterwards.”

Arthur Koestler, 1964, Author of The Act of Creation and The Ghost in the Machine.