Taking the Mystery Out of Investor Behavior

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If you were asked how well your company knows its investors, you’d probably answer, without hesitation, “Very well. ” After all, you’d point out, your top executives including your CEO spend a lot of time talking with big investors and influential analysts in conferences, conference calls, or one-on-one meetings, and you have an active investor relations team that stays in close touch with the investment community. But what if you were asked how, exactly, investors would react to any particular strategic decision your company might make? If you’re like most executives, your answer is unlikely to be very illuminating.

Consider this. We recently asked the CEO of one McKinsey client how he thought investors would respond to the upcoming sale of a major operating division. Although he claimed to spend twice as much time with investors as his competitors’ CEOs did and employed both in-house investor relations (IR) staff and IR consultants, the CEO couldn’t quantify the value that his company’s major investors ascribed to the division or even identify the synergies that they assumed existed between it and other divisions. It was impossible, therefore, to do more than guess at the market’s reaction to the announcement of the forthcoming sale. And even when CEOs do understand fairly precisely what their largest ten or 20 investors think, they often mistakenly take the views of the large shareholders as guides to the opinions of smaller ones. That thinking caused trouble for another of our clients when three investors—which were not among the 20 largest or most influential ones—unexpectedly sold all their shares following an announcement, driving the stock price down 15%.

The sketchy knowledge companies typically have about their investors contrasts strikingly with the close relationships they usually have with their customers, especially in B2B industries, where senior managers are very familiar with the needs and preferences of their leading clients. Indeed, these managers employ armies of researchers and national-account sales teams to investigate and explain the purchasing patterns of top customers. Money center banks, for example, have two to five full-time relationship officers for each of their 50 largest accounts. Managers will not make even minor decisions about product changes without conducting a detailed, quantitative analysis of their customers’ likely reactions.

We believe that managers need to adopt the same philosophy toward investors. After all, a major decision by a key investor will likely have a greater long-term impact on shareholder value than will a decision by the average large customer. And it’s easy to gather information from key investors. They’re usually willing to share their views of a company, its competitors, or an industry when approached in the right way. In addition, public reporting requirements for institutional investors in most developed countries make it possible for a company to carry out a deep analysis of investors’ purchases and sales of the company’s stock and that of other companies. These two sources enable companies to develop as detailed a picture of their investors’ trading behavior as of their customers’ purchasing behavior.

In the following pages, we’ll present a new approach to IR—called investor-based finance (IBF)—that can help companies create that picture. Specifically, we’ll describe how companies can use IBF to identify their key investors, derive information about those investors’ finances and trading patterns, and outline a basic framework for profiling investors according to how far out—long, medium, or short term—they look at information and what kind of information they value and use. We’ll also show how companies can quantify the potential impact of investor decisions on their share prices. Finally, we’ll describe how several McKinsey clients have used a comprehensive knowledge of investor motivations to inform the formulation and implementation of their strategies.

Let’s begin, though, by exploring why IBF represents a major shift in thinking about the relationship between managers and investors and, indeed, about the nature of the financial marketplace.

One Size Does Not Fit All

In the traditional model of corporate investor relations, managers unwittingly focus more on what they want to say than on what the audience hopes to hear. When preparing to meet with investors, a company will typically develop a standard communication package. A CEO or IR manager might prioritize some portions of the package for certain investors, based on past experience, but the essential message is usually the same for all. Little or no effort is made to tailor messages, communication techniques, or facts to specific investors. Yet anyone with marketing experience understands how investors, like customers, routinely misinterpret corporate messages, which are often quite complicated. (We’ve even encountered instances in which investors sold shares by mistake.) Further, as with customers, investors often have different preferences for various types of risks, strategies, and so forth. Understanding these investor differences allows companies to more carefully target their communications.

According to many financial academics, though, it doesn’t really matter if some investors misunderstand a company’s message because financial markets are considered to be “efficient.” In an efficient market, not only do investors make decisions based on rational analyses of a company’s long-term financial expectations, but there are also enough other current and potential investors so that even if some sell out, others will step in to replace them. Once a company’s managers develop a new strategy for creating value, therefore, all they have to do is explain their rationale for it. It’s not hard to see the appeal of this theory because it suggests that managers can ignore the complex behavior of investors and concentrate instead on more familiar constituencies: customers and employees.

There are a number of problems with this picture. First, most companies whose stocks are not widely followed have a hard time capturing the attention of the market. For a company like this, a move that occasions some small number of shareholders to sell out can cause an enduring decline in stock price because years may pass before enough new investors recognize the company’s value and purchase its shares. For instance, one of our industrial clients with a market cap of approximately $1 billion announced a major shift in strategy in mid-2001. It invited more than 30 potential institutional investors to meet with the CEO to hear about the new outlook for the company. Not one investor accepted. In addition, when the move was executed, a number of shareholders sold, driving the stock price down 30%. Only in the spring of 2002 did the stock begin a serious recovery.

Second, and more important, however, a growing body of empirical research suggests that large companies are just as vulnerable to the decisions of a small number of investors as small or midsize companies are. Our firm recently completed an in-depth, quantitative analysis of the share price performance and investor trading behavior for companies in the S&P 500 index, whose market caps range from $500 million to $200 billion. The study revealed that some 70% of company-specific stock price changes (that is, those above and beyond general sector or market movements) in the quarter following major announcements could be explained by trades by its 40 to 100 most active investors.

Large companies are just as vulnerable to the decisions of a small number of investors as small or midsize companies are.

Take a look at the exhibit “Tracking the Movers and Shakers,” which shows how trading by 50 key traders in a large financial services company affects the company’s stock price. The graph’s x-axis tracks the net sales and purchases of those investors; on the y-axis are contemporaneous changes in stock price relative to the general market—that is, with the effects due to general market shifts stripped out. The line, the best-fit regression line to the points, shows the expected relationship between the change in trading position and the change in share price. The tight clustering of the points around the line indicates a close correlation between the net change in the collective holdings of the 50 key investors and changes in the company’s stock price.

We conducted similar analyses using quarterly data for a total of 40 companies, and in 35 of them, trades by the most active investors (between 40 and 100 of them) accounted for more than 50% of the stock price movement. Analysis using weekly data increased the accuracy of the correlation by ten to 20 percentage points. What’s more, the relationship seems to hold quarter after quarter, indicating that the net trades by the most active investors are not usually offset by subsequent trading within the rest of the market. In other words, the changes in the share price are usually long lasting, sometimes permanent.

That can be painful. A medium-term decline in a company’s stock price can derail the execution of a growth strategy based on M&A, because companies will lose value-creating acquisition opportunities to their competitors. Indeed, as many large companies have discovered, a depressed share price can even turn a onetime corporate acquirer into an acquiree. Organizational consequences can arise, too: Companies become vulnerable to losing capable CEOs because the market often expects senior management to atone for poor share-price performance with their jobs; and companies that rely on share-option schemes to reward and retain talented managers may lose those people to competitors.

Clearly, companies cannot afford to simply let the stock price take care of itself, as the traditional model of financial market efficiency implies. As our research shows, the buy, sell, or hold decisions of a relatively small number of current and potential shareholders play a large role in determining the impact of a company’s strategic decisions on its share price. Companies that identify their key investors and understand what drives those investors’ decisions can better predict—and very possibly shape—the impact of their own business choices on the share price.

Identifying Key Investors

A company’s key investors are not necessarily its largest shareholders. Some large shareholders—especially in big companies—are passive investors that hold their stock for years. Others’ positions are determined by the company’s inclusion in a market or sector index. These latter investors buy, sell, or hold based on the overall appeal of the stock market or the sector, and they will play a major role in determining company-specific movements in the share price only following unique, easily recognizable events. For example, when a company is dropped from a market index, a flurry of selling activity may take place from passive investors rebalancing their portfolios.

Those occasions aside, a subset of active traders in a company’s stock constitutes the group of investors with the most influence on stock price, and these investors typically come in four guises. Some are large shareholders that, for their own reasons or as a result of changes in a company’s strategy, suddenly burst into life. Others are past shareholders that, for similar reasons, buy back into a company. Still others are those small, current investors that are willing and able to substantially increase their holdings or trade in and out of them very actively and frequently. Finally, some future influential movers currently trade in comparable companies but have never owned shares in the company in question. The first step, therefore, in identifying your company’s active traders is to make a list of all the actual and potential investors that match those descriptions.

Your list will certainly and fairly easily capture the majority of a company’s current and past key investors. As part of the research mentioned above, we analyzed the large institutional trades in eight companies over a year. We found that, on average, fewer than 100 traders accounted for more than 90% of the trades. Looking more closely at those 100, we saw that about 30% of those trades were made by investors that held large amounts of the stock on January 1. About 25% were carried out by investors with small holdings on January 1 but with the resources to become big players. Another 20% came from investors that held no stock as of January 1 but that were predicted from their history to become big players. Only about 25% of the trades were made by investors that we wouldn’t have guessed would be interested in the company.

After compiling your list, the next step is to establish the patterns that characterize each key trader’s buying and selling behavior in your company. Most investors have formal and informal rules governing the ways they invest and trade. To begin with, professional fund managers usually have an upper limit—usually around 5%—on the size of their holdings in a particular company. In some cases, the limit is driven by the fund manager’s desire to maintain a diversified portfolio. In other cases, the limit may exist to keep the fund manager below a regulatory threshold (in some countries, holdings above 5% require a public announcement). Many investors also have concerns about trading liquidity and will not own more shares than are typically traded in a company in three to five days, which often results in an even lower practical upper limit on their holdings. Finally, investors differ markedly in their trading styles. Some, such as Fidelity, are “blasters”: When they decide to sell a stock, they rapidly reduce or eliminate all holdings. Others, such as Janus, are “bleeders”: Once they decide to sell, they take as long as nine months to fully liquidate their position. Some investors are limited to making only a single investment in a company; once they invest, they can only hold the stock or sell.

Much of the necessary information about investment policies and trading norms is made public by investors themselves. You should carefully review SEC 13(f) filings (reports by institutional investment managers with discretion over $100 million or more in securities, required under the Securities Exchange Act of 1934) and stock surveillance reports to determine investors’ actual trades of your stock and those of comparable companies. You may find contradictions between formal and informal practices. For example, in its November 2000 registration statement with the SEC, the Putnam Voyager Fund stated that it would not own more than 10% of any issuer or invest more than 5% of the fund’s value in any one stock. Analysis of actual trading and holding behavior suggested more conservative holding limits: At the time of the filing, Putnam Voyager did not invest more than 3.8% of its fund in any one company, and, in fact, more than half of its holdings were in companies in which it invested less than 1%.

By matching observed behavioral characteristics to one of the four investor categories mentioned above, you can further narrow the list of likely large active traders. At one company, for instance, we found that all the key investors had either bought shares slowly over time or built up their position within a few weeks; they did not combine the two approaches. We were therefore able to eliminate from the list of likely large active traders all those investors (many of them deep-pocketed) that had traded busily but had not ended up with large holdings in the company’s stock.

You can also use the trading data to compare an investor’s movements in or out of a stock with its movements in and out of the company’s sector as a whole. This comparison can help you determine whether the investor is buying or selling because it is bullish or bearish on the company, the sector, or both. Other revealing analyses include examining an investor’s holdings in a company relative to its average holding size of comparable companies, the duration of those investments relative to the average holding time, and so on.

Although large active traders are the most important group of investors, they are not the only ones that matter in determining how a company’s share price will react to changes in strategy or management. Small and mid-size investors that spontaneously react the same as one another to a particular event can have a major impact as well. For example, we identified a group of regular traders in a biotech company’s stock that always sold when acquisitions were announced.

To identify whether such like-minded small investors are essentially trading a company’s stock as a group, you need to identify times when a meaningful change in stock price occurred in the opposite direction from that caused by the actions of the large active traders alone. Then, by cross-checking the buying and selling of the smaller investors relative to external media events such as press releases, you can determine whether certain shareholders consistently buy or sell following the release of a certain type of news. Often, investor groups will follow the lead of a single prominent independent analyst such as David Tice, whose damning analysis of Tyco’s financial reporting caused that company’s stock to fall sharply.

Building Investor Profiles

Even well-informed and sophisticated investors can have varying opinions about what will move a company’s stock. Recently, for example, we interviewed ten key shareholders of a large industrial company over a two-day period. Although all were professional institutions, their estimates of the company’s value varied dramatically, diverging by a factor of five. In our experience, the causes of these differences can best be understood by comparing investors along two dimensions: their horizon of analysis and the dominant content being analyzed. Mapping active investors in this way helps companies both to understand what information those investors rely on in forming valuation judgments and to predict how those investors will likely react to different kinds of news. Once again, most of this information can be obtained by analyzing trading patterns and posing questions directly to the investors.

Horizon of Analysis.

In order to predict a stock price, an investor will use an analytic “valuation” model through which it processes information about the stocks it trades. This model can be as detailed as a 20-page spreadsheet or a simple as a single financial ratio. But whatever form it takes, each has a time horizon, a point beyond which the investor believes that information about a company has no predictive impact on its future stock price.

We call investors with the longest horizons fundamental analysts, and they are epitomized by investors such as Warren Buffett and Sanford Bernstein. Fundamental analysts base investment decisions on comparisons between a stock’s current price and the value estimated from a careful analysis of the company’s long-term (five years or more) prospects, typically calculated through a discounted cash flow (DCF) model. These investors are likely to be most interested in information such as long-term growth projections, believing that shorter-term estimates possess too much “noise.” Because of the long horizon of analysis, wide variations among fundamental analysts can emerge about a particular company’s value: Small differences in assumptions can lead to big differences in value when calculated over many years.

It’s important to realize that fundamental analysts don’t have to be long-term investors. If events cause a stock’s price to swing significantly around its theoretical long-term value, an active fundamental analyst can certainly be an active short-term trader. Fidelity, for example, is well known for valuing companies using a long-term model but is just as well known for its aggressive trading of the stocks it follows. In fact, only a very few fundamental analysts have investment horizons as long as their analysis horizons.

Many companies make the mistake of assuming that all professional investors are fundamental analysts. But we’ve found that less than half of most companies’ key investors adhere to this philosophy; in some cases, the proportion is less than 10%. Indeed, for many companies, the majority of large active investors will have a medium-term horizon of analysis. These investors, called news forecasters, are interested in whether a company will release substantive news or make changes within 12 to 18 months. They try to predict a pattern of the news or announcements that a company might make, and they buy and sell stock based on those predictions. About one-third of institutional assets in the United States appear to be controlled by investors with this philosophy.

The investors with the shortest horizon are event bettors. These investors closely follow a company’s actions, buying or selling ahead of specific news such as earnings predictions or the outcome of a major contract. Event bettors, on average, are smaller investors than fundamental analysts and news forecasters, but they can certainly be among a company’s top 100. The pressure routinely created by their presence helps explain the Wall Street adage, “Buy on the rumor, sell on the news,” referring to the perception that stocks often seem to rise in advance of good news but fall back a bit after an actual announcement. That’s when event bettors are closing their bets.

The horizon of analysis for a company’s key investors can seem ill-matched to its industry. Biotech, for example, is a long-term business—most of the value that companies create with their products will not be realized for ten to 20 years or more. As a result, you might expect fundamental analysts to dominate the shareholders’ register and therefore the share price. But our work shows the opposite. In some portions of the biotech sector, nearly 90% of the active institutional investors are news forecasters or event bettors that make investment decisions based on very near-term events such as clinical trials. It seems that fundamental analysts have simply given up trying to analyze companies with such uncertain prospects.

Dominant Content Being Analyzed.

In addition to understanding each key investor’s horizon of analysis, companies also need to understand what kind of information investors look at. Most large investors will, of course, be familiar with the dynamics of a company’s industry; as Warren Buffett points out, it’s unwise to invest in a company whose products and risks you don’t understand. But investors can vary widely in what they think drives value. Often, many will cite no opinion about a strategy announcement that a company considers extremely significant.

At one end of the spectrum are investors—we’ll call them organization mavens—that focus almost exclusively on organizational issues: These investors may sell or buy shares after examining a company’s measures for training frontline management or following a change in senior management. For instance, one group of companies in the 1970s was known as the death watch stocks. These companies were run by aged, unpopular CEOs (Armand Hammer at Occidental Petroleum was a case in point) who for various reasons could not be dislodged. The stock price of one of these companies would rise on news that its CEO had been hospitalized and would fall again when he recovered.

By contrast, strategy junkies focus on questions about strategy and operations. Does the company have a particular edge in cost structure or technology? Is it the dominant player in its value chain? Is a substitute product or service threatening its position? And at the other end of the content spectrum we find the financials addicts, investors that base their decisions almost exclusively on a company’s financial condition and results. A financials addict, therefore, might well sell out if a company misses an earnings estimate or if its operating margin deteriorates.

It’s critical to determine the dominant content that an investor analyzes so that you can frame your communications to that investor. In seeking support from an organization maven for an acquisition, for example, managers should provide details on how the company plans to handle the inevitable culture clash.

An investor’s horizon of analysis is independent of the dominant content being analyzed. Some fundamental analysts, for example, will be organization mavens while others will be strategy junkies. Similarly, event bettors are as likely to be financials addicts, trading based on an earnings announcement, as they are to be strategy junkies, buying ahead of news on a major contract.

Because these dimensions are independent, it’s possible to classify most large active investors as one of nine basic types, but in practice, the differentiation among types is not always clear-cut. Although we doubt that any one company will have investors of all types, most will have a mix of them. The exhibit “Different Strokes for Different Folks” provides a comparison of the nine types of investors.

Different Strokes for Different Folks This table contrasts typical hypothetical statements by investors focused on different horizons—long-, medium-, or short-term—and attuned to varying content—organizational management, strategy, or financials. Of course, actual comments on real investments will probably be less clearly distinguishable from type to type, and investors of the same type can always hold divergent opinions. Nonetheless, these hypothetical quotes illustrate the philosophical differences mentioned in the article.

Predicting Their Reactions

The final step in an investor-based finance analysis is to predict how the identified and profiled key investors will react to specific strategic or organizational changes. In some cases, those reactions can be deduced from historical trading patterns. Our analysis of trading in an industrial conglomerate with four divisions, for example, revealed that more than 35% of its shareholders valued only two of the divisions: When we examined the shareholders’ holdings in several external competitors, we discovered that they held shares, and were even increasing holdings, in those companies that competed with the two divisions. By contrast, the same shareholders had not held any shares in the competitors of the other two divisions in several years. Consequently, if the conglomerate were to split into two companies along certain lines, we could assume that those investors would likely sell one of the resulting companies.

Most initiatives, however, are too important or too subtle to rely solely on an analysis performed from the outside looking in. For instance, if a company is considering a new service-based strategy, it probably can’t deduce enough, from past trading behavior alone, about how each individual investor views services. Any company contemplating a major strategic initiative should, therefore, canvass investors on the crucial issues at least six to nine months before it actually faces a decision. Fortunately, most large investors recognize that it is in both the company’s and their own interests for the company to understand how they think.

In undertaking such a process, the principal challenge is to avoid asking questions that may be construed as passing insider information or violating Regulation FD (the SEC regulation on fair disclosure), which since 2000 has required companies to announce news to all investors and the public at the same time. We believe that this regulation does not prohibit detailed, focused discussions between companies and investors; does not restrict companies from asking questions of investors; and does not proscribe investors from communicating their views to companies. The SEC expects companies to use good judgment in determining that any particular information they give some investors will not be judged material by other investors.

Interviewing investors can be done in two ways. First, you can focus the conversation on an investor’s publicly known activity in the shares of other companies. For example, if your company is considering international expansion and notices that an investor has just sold its shares in another company that recently announced plans to enter China, you can ask the investor why it decided to sell. The investor may have sold because it thinks the risks of investing in China are too great or because of another, unconnected reason, such as the comparable company’s failure to meet an earnings target. Whatever the reason, you can ask about the sale without overtly signaling your own intentions. Obviously, your true reasons for questions won’t be easily discerned if the China move was one of several events that could have caused the investor to sell out.

An alternative approach is to ask, sometimes through a third party, about the investor’s views on a number of hypothetical but plausible strategic options. A shareholder won’t be able to deduce which options are real and which are designed to prevent the unintended transfer of inappropriate information. For instance, we have conducted interviews with investors using a “clean team” that could truthfully tell investors it hadn’t previously worked with the client and thus the investors shouldn’t read anything into its questions.

Estimating Share Price Movement

The information gleaned during investor identification and profiling can be used to determine the likely trading imbalance, positive or negative, attributable to key investors following a major event. As we showed previously, the trading actions of key investors can be plotted on a graph in comparison with changes in stock price and a best-fit line of regression obtained. To determine the most likely company-specific change in stock price, locate on the x-axis the net number of shares to be traded, move up or down to the point of intersection on the line of best fit, and read over to the y-axis.

Let’s look at the following simplified hypothetical example. Quincy Corporation is considering acquiring Savannah Incorporated to round out its product array. Savannah, which has always prided itself on its entrepreneurial independence, is about one-third Quincy’s size. Quincy plans to pay a 30% premium, and its directors are comfortable with the acquisition as long as they can be reasonably sure that its stock price will not fall by more than 10%. Quincy’s IR department has previously established that its stock price is driven by the decisions of 90 large active traders. Groups of smaller like-minded shareholders have historically had little impact, even when Quincy made acquisitions.

The IR department first estimates the likely trading reactions of each of its 90 top investors, beginning with the largest shareholder, the Jordan Investors Fund, which has about 1 million shares. Jordan, a fundamental analyst and strategy junkie, is expected to be highly supportive: It bought lots of shares during Quincy’s previous acquisitions, and in recent discussions, its top analyst expressed a belief that a full product line was critical in Quincy’s industry. Unfortunately, it turns out that Jordan already holds as much Quincy stock as it can. Quincy already constitutes 3% of the fund—below its official limit of 5% but well above Jordan’s average holdings in any company over the past three years. Further, Jordan’s analyst had had to fight for authorization to make the most recent purchase of stock because the company’s holdings already represented five times the average daily trading volume in Quincy stock, and the investment committee was very uncomfortable with anything over four times. The IR department concludes that while Jordan is unlikely to sell any stock, it is also unlikely to buy any more.

A similar analysis of the next most significant active trader, the Mazie Fund, produces a more severe result. Mazie has been critical of Quincy’s cutthroat approach to integrating previous acquisitions. Earlier in the year, Mazie had reduced its holdings to 500,000 shares following newspaper stories about layoffs at Quincy’s recently acquired production facilities. Given that the Savannah acquisition will result in several plant closings and that Quincy plans to apply its famous “process discipline” to Savannah’s product development, Mazie can be expected to dislike the deal intensely. Worse, Mazie is a blaster: In more than 80% of the cases in which the fund sold out following similar mergers in the previous two years, it sold 75% to 100% of its shares within one quarter. After considering this and other factors, the IR team concludes that there is a 90% probability that Mazie will sell all 500,000 shares within a quarter. There is only a 10% likelihood that it will retain even 100,000.

After reviewing each of the top 90 key investors in this way, the team tallies the results. Twenty-five investors are likely to buy between 12 and 13 million shares. Another 20 are likely to maintain their existing positions, either because they will probably feel neutral about the acquisition or because they are at their holding limits. Forty are likely to sell between 18 million and 19.5 million shares. Five investors are too difficult to predict but can probably be influenced in Quincy’s favor, provided the company convincingly and strategically announces the deal; the team estimates that the net change in shares will be somewhere between a sale of 0.5 million and a purchase of 0.4 million.

The team concludes, therefore, that the top 90 traders will reduce their net position by anywhere between 4.6 million (best case) and 8.0 million (worst case) shares. The most likely outcome (indicated in the graph “Reacting to the News” and estimated by a purchase of 12.5 million shares by supportive investors, a sale of 18.5 million by nonsupportive investors, and no change by those on the fence) is a net sale of 6.0 million shares. Now look again at the line of regression and the band indicating a 90% correlation between changes in net trading position by the 90 key investors and changes in share price. You’ll see that a sell-off of 6.0 million shares by those investors most likely translates into a 4.1% fall in share price, although the actual fall could be anywhere between 2.1% and 6.1%. If sales fall at the extremes of 4.6 million and 8.0 million, the share price is predicted to fall between 1.0% and 7.5%. Thus, although it is not impossible that the actual outcome will be different, the Quincy board can feel relatively comfortable about approving the Savannah acquisition.

Shareholder Value

The knowledge about investors that companies obtain using IBF is helpful not only in framing and selling strategic decisions to investors but also in actually making the decisions. Companies can, for example, use the predictions as a tiebreaker when deciding between two or more strategies with equivalent net present value. In other situations, in which strategic success requires future access to the capital markets or a healthy currency for acquisitions, companies need to maintain a buoyant stock price in the short-to-medium term to ensure the overall success of the strategy.

In one recent example, a biotech client of McKinsey’s was trying to decide where to place its main R&D investments. It had the scientific knowledge to choose any or all of some two dozen projects but had the financial resources to pursue only a few. Because the science was in its early stages, DCF-driven analyses were unusually sensitive to changes in assumptions—any one of which could be reasonably altered. The company could not, therefore, rely on traditional valuation tools in making its strategic R&D choices. IBF eventually helped the company identify the options that would be most favorably received by its current and potential key investors.

IBF can also help companies in strategy implementation, specifically in the timing, pacing, and sequencing of particular steps. Knowledge of this sort could have greatly benefited one consumer products client in implementing its acquisition strategy. The company had hired a leading management team to head its about-to-be-acquired operations, which were all in a new area of business for the company. But it had chosen not to go public with the information about the new team because such an announcement might have interfered with ongoing acquisition negotiations.

The trouble was, a few key investors sold the company’s stock heavily on the news of the first acquisition, causing its market value to fall by more than 15%, because those investors didn’t think the company had the management skills to enter the new market. If the company had announced the hiring of the new team, that loss might have been avoided. But in this case, the damage was permanent: After selling their shares, the investors quickly invested in other companies, and the price did not return to its original level even when the news of the new management team was released.• • •

Philosophically, investor relations today is where marketing was in the early part of the twentieth century. Back then, most CEOs felt that they personally knew their customers and couldn’t understand how a systematic analysis would add to their understanding of customer preferences, beliefs, and judgments. But the advent of marketing science changed this perception, which in turn fundamentally changed the way that managers manage. Customer analysis led to highly tailored marketing campaigns. It also became a critical component for product development. For instance, the realization that Europeans had smaller kitchens prompted U.S. manufacturers to develop cleaners and detergents in smaller containers. Today, observations and forecasts from in-depth customer analyses are also crucial elements in predicting demand, thereby shaping decisions about plant capacity and distribution strategy. Why shouldn’t the same thing happen with investor relations?

A version of this article appeared in the September 2002 issue of Harvard Business Review.
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