It's a sad truth in corporate America: Annual letters to shareholders from CEOs of troubled companies often contain only upbeat and encouraging words. Executives rarely confront or admit problems, or discuss them honestly with shareholders.
Here's a welcome exception to that rule from Callaway Golf (NYSE: ELY) CEO George Fellows, in the most recent annual report on the company's website:
Despite the significant progress we've made as a company, we recognize that we still have work to do. The underperformance of our Top-Flite brand has been an area of concern for our Company over the past few years. Its downward trend cannot be reversed overnight, but the introduction of the unique new D2 Golf Ball in early 2007 should provide a much-needed boost and help launch a rejuvenation of Top-Flite.
Even if his expectations prove too optimistic, Fellows has still acknowledged up front that the Top-Flite division has been underperforming for several years. Similarly, management at The New York Times (NYSE: NYT) noted in the company's 2006 letter to shareholders, "We are proud of what we have accomplished, but we also recognize much more needs to be done to improve our financial performance."
In contrast, look at Time Warner's (NYSE: TWX) 2006 letter to shareholders. The company's stock has been trading mostly in the teens for six years now. (Trust me on this -- I'm a shareholder.) Yet the letter tells investors: "We believe all of our hard work against our strategy has contributed to improvements in our stock price in 2006. But we are by no means satisfied, and we are dedicated to redoubling our efforts to build even more value for our shareholders."
That may sound good, but the company mainly points to dividend payments and stock repurchases as examples of shareholder rewards. It would be better to see the company robustly and reliably building revenue and earnings.
Trends and correlations
At Rittenhouse Rankings, former investment banker L. J. Rittenhouse specializes in reviewing annual reports' CEO letters to shareholders, evaluating them for candor. In her 2006 survey, Toyota (NYSE: TM) and Alcoa (NYSE: AA) won top marks; Boeing (NYSE: BA) and Cigna (NYSE: CI) earned the lowest.
Rittenhouse reported that in shareholder letters released during 2007, "88% of newly-installed CEOs rank below the survey's top CEO quartile in providing meaningful and straightforward information." In other words, the new CEOs aren't as frank as longer-tenured ones.
What's the fuss?
While CEO candor is welcome, it might seem less than critical. After all, we can generally see when a company is struggling -- do we really need the CEO to admit the obvious and share details with shareholders? Absolutely, according to Rittenhouse's research.
She found that among the new crop of CEOs from 2005 and 2006, those with the biggest improvements in their content scores (over scores earned by predecessors) significantly outperformed their peers -- posting an average stock-price gain of more than 28%. Meanwhile, those with the largest score drops saw their stocks drop an average of 11%.
She explains: "Companies with CEOs ranked low in candor tend to articulate less coherent strategies and therefore, undermine execution in producing desired results. Given the value-building benefits of authentic and clear CEO communication, boards of directors have a duty to select new candidates that set an example for candor throughout the corporation." (Interestingly, she found that new CEOs hired from within tended to exhibit more candor.)
What to do
Pay attention to company communications. Read CEO letters to shareholders, asking yourself how much honesty you see and how clearly the CEO details his vision of the company's strategy.
Remember: A company's management works for you and its other shareholders. If you don't hold managers accountable for the way they run the company, you can't complain when they do a bad job. Stay informed, and if you see managers being less than open about problems, think twice about whether your money's in the right place.
