Chapter 8

Focus on Relationship Building

Among the problems investor relations executives consider important for the future of the investor relations profession, one of the most important is the short-term fixation of shareholders.¹ Short-termism of investors can harm companies. Wolff-Reid explains, “In recent years, Wall Street’s obsession with beating quarterly numbers has been a destructive force, pushing companies to focus on short-term results down to penny.”² Thus, it becomes an investor relations’ responsibility to extend the horizon of the investors, or, as Bill Nielsen, a former Johnson & Johnson’s vice president, phrases it, “Turning stock-holders into stock-owners.” Communicating information beyond the U.S. generally accepted accounting principles (GAAP) requirements helps to achieve this goal by building a deeper understanding of the company’s future and thus building a relationship between investors and a company. One of the anonymous investor relations practitioners in Laskin’s study on the value of investor relations elaborates,

Since we have invested the time and effort in building relationships… we are given the opportunity to explain our results and strategies more fully, and have a better chance to be given the benefit of the doubt in situations where investors and analysts are being asked to trust your word than if we didn’t establish the relationship. ³

Increasing the holding period and amount of ownership in the company can help stabilize the share price volatility and thus is a part of investor relations job. Such holding pattern is sometimes referred to as relational investing.⁴ Investor relations academics and practitioners know of benefits of relational investing:

The rewards of this relationship can be significant. Value gaps tend to diminish because investors believe management can accomplish what it says. Positive events and development earn higher stock gain rewards. A flat or down quarter isn’t an automatic sell signal. Investors look for explanations and, when convinced that fundamentals are still strong and growing, are more likely to hold their shares or even increase their positions. Patience is more likely to be accorded.⁵

An academic study that analyzed relational investing noted that although the term becomes quite common, there is no precise definition for this phenomenon:

The proponents of relational investing do not define who counts as relational investor, beyond the vague requirement that the investor hold a large block for a substantial time and actively monitor the firm’s performance, nor do they specify how quickly the results of the investor’s monitoring should show up in a firm’s performance.⁶

The development of such relational approach parallels a similar approach in marketing, where the 1980s and 1990s brought a shift from transaction-oriented marketing to relationship-oriented marketing.⁷

Others use a similar term, relationship investing, and define it the following way: “Simply put, whenever there’s an established, committed link between a company and one or more shareholders, that’s relationship investing.”⁸ Relationship investing, thus, becomes synonymous to relational investing. They both mean long-term investing, investing in a large share of a company’s stock, and finally active monitoring of the corporate actions.

As mentioned earlier, this can create several benefits for the company in the long run: “First, it helps solve a problem executives have complained about for years: short-term investing. By creating a class of enlightened investors who give companies patient capital, relationship investing should free management to focus on the long term.”⁹ This long-term focus should enable the company to invest in such activities as, for example, research and development, thus improving the firm’s competitiveness in the long run.

Furthermore, “the very existence of a new breed of active capitalists fixes another failing of U.S. corporations: the imperial CEO, unchecked by a pliant board of directors… Investors who actively monitor their holdings would introduce a badly needed measure of management accountability.”¹⁰ An academic study analyzed several cases of investors getting closely involved with the companies (e.g., Avon, Kodak, Sears, Lockheed) and all these cases improved their corporate performance after active involvement of shareholders in company’s activities.¹¹ Across the literature, there is “a variety of evidence, some systematic and some anecdotal” that can support the claim that long-term investing can lead to improvements in corporate performance.¹²

So, relational investors instead of “trading stock like pork bellies” exhibit a real long-term interest in the company, its management, the way it is run, and the way the company communicates with them. Relational investors are the ones who want to influence the company’s management and provide advice on how the company should be run. They are also often the ones who have the power to assert such an influence. Relational investing requires the presence of a strong, competent, and influential shareholder.¹³ As a result, relational investing is an underlying reason behind shareholder’s activism, a sign of shareholders’ involvement in the company’s future. The presence of a strong shareholder that can and want to influence the company’s decision-making process might cause panic for some managers.¹⁴ On the other hand, companies that pay attention to the expertise and knowledge of such shareholders are often rewarded with long-term, sustainable financial success.¹⁵ In simple terms, relational investors provide patient capital in exchange for increased accountability.

The terms relational investing and relationship investing, however, both look at the issue from the standpoint of the investment community. Analyzing the same issue from the standpoint of a corporation and its investor relations practitioners, this issue can be labeled investor relationship. The term would encompass the efforts of the investor relations professionals to recruit or develop long-term relational investors for their companies by building relationships between shareholders and the company. Thus, the term investor relationship builds on the traditional corporate function of investor relations but places an emphasis on the importance of developing relationships with shareholders, helping them to become relational investors or engaging them in relationship investing.

The benefits of investor relationship are not limited to just corporations and investment community. In fact, relational investing has a potential of solving the common problem of investors’ rational apathy—a situation in which investors prefer to withdraw from the company (selling the stock) if faced with a problem, bad corporate practices, or unethical behavior.¹⁶ The group of experts on corporate law charged by the European Commission with the task of researching corporate practices in Europe concludes,

From the viewpoint of a single shareholder, it may frequently seem appropriate to sell his shares if he is dissatisfied with—or lacks confidence in—incumbent management, rather than try to change things within the company. However, this “rational apathy” may prove very disadvantageous if adopted as a general attitude among shareholders.¹⁷

Relational investors, however, do not sell the stock in a similar situation. Rather, they try to communicate their dissatisfaction to management and persuade the company to change its policies. In other words, instead of fleeing from the problem, relational investors work on solving it. These investors provide their skills, knowledge, and expertise to the company and thus can potentially lead to improvements on the company’s side. Such investors strive to get above-average returns from their investment in the company, not from their investment in the market.

Investor relationship, however, heavily relies on the extensive disclosure that goes beyond minimum U.S. GAAP requirements. Strategic investors need to understand the company as well as managers do and as a result want additional information. Thus, extended disclosure of both financial and nonfinancial information is an essential part of investor relationship.