Remarks on Raising Capital by Selling Securities to the Public John C. Edmunds Professor of Finance June 2, 2004

Professor John C. Edmunds Boston, Massachusetts 2 A Landmark Event in a Company’s Progress When a company sells securities to the public for the first time, the event marks a major step upward for the company. The company comes to the attention of millions of people who never heard of it before. The company acquires a halo of positive publicity.

Professor John C. Edmunds Boston, Massachusetts 3 A Landmark Event, 2 The company has a shining opportunity to build on the positive image and convince investors that it is going to become a major participant in the world economy. If investors become convinced that the company is going to deliver rewards to minority shareholders, they bid up the price of the company’s securities.

Professor John C. Edmunds Boston, Massachusetts 4 Building a Reputation After a company successfully places its first public issue of securities, the most important phase of the work to build its reputation begins. To build a reputation requires putting high priority on communication, in addition to achieving sales growth and operating performance.

Professor John C. Edmunds Boston, Massachusetts 5 Building a Reputation, 2 The company’s top priorities need to include communicating with securities analysts, financial news media people, and securities market regulators. The most important group to communicate with is minority shareholders and institutional investors.

Professor John C. Edmunds Boston, Massachusetts 6 Building a Reputation, 3 Securities analysts, financial news media people and securities regulators will expect to be kept up to date. Minority shareholders and institutional investors will be extremely attuned to the signals the company sends.

Professor John C. Edmunds Boston, Massachusetts 7 Building a Reputation, 4 If the company devotes adequate attention and priority to managing its relationships with minority shareholders and with institutional investors, the company will quickly be able to raise new amounts of capital, and will be able to expand by acquiring its rivals.

Professor John C. Edmunds Boston, Massachusetts 8 Building a Reputation, 5 Minority shareholders and institutional investors are wary and nervous when they buy securities issued by a company that has not issued securities before. The company has no track record of dealing with the investing community.

Professor John C. Edmunds Boston, Massachusetts 9 Building a Reputation, 6 Many companies assign a low-level person to the job of investor relations. This is a big mistake. Top management should devote time to this most important job. Consultants can help but cannot be effective if top management does not take the matter of communication seriously.

Professor John C. Edmunds Boston, Massachusetts 10 Advantages of a Good Reputation Companies that communicate well with minority shareholders and with institutional investors can sell additional issues of securities. Companies that communicate well can lower their cost of capital.

Professor John C. Edmunds Boston, Massachusetts 11 Advantages of a Good Reputation, 2 In capital intensive businesses, having a low cost of capital is a big advantage. The company with the lowest cost of capital in its industry sector can buy control of competitors that have higher cost of capital. They can also grow from within more quickly.

Professor John C. Edmunds Boston, Massachusetts 12 Advantages of a Good Reputation, 3 Companies that communicate well with minority shareholders and with institutional investors can attract the most highly qualified employees. They can offer stock options to their employees. Employees will place a high value on these stock options. They will be loyal to the company.

Professor John C. Edmunds Boston, Massachusetts 13 Content of the Communication The communication has to be timely and accurate. Minority shareholders and institutional investors always worry that the information they are receiving is out of date or inaccurate.

Professor John C. Edmunds Boston, Massachusetts 14 Content of the Communication, 2 Investors always worry that some investors are more informed or are receiving news before it is generally announced. Whenever the company has any news, all investors must learn the new information at the same time.

Professor John C. Edmunds Boston, Massachusetts 15 Content of the Communication, 3 Minority shareholders and institutional investors are very savvy and will almost always be able to tell if the information they are receiving is inaccurate or if there is some group of investors who is finding out the new information earlier.

Professor John C. Edmunds Boston, Massachusetts 16 Content of the Communication, 4 If minority shareholders and institutional investors think they are being told too late about events, or if they think they are being deceived, their reaction will be swift and damaging. The company will not be able to raise any more money, and the prices of securities it sold in the past will crash.

Professor John C. Edmunds Boston, Massachusetts 17 Protocols of the Communication Communication must be two-way. The company tells minority shareholders and institutional investors what its performance has been and what its plans for the future are. Minority shareholders and institutional investors then tell the management what they think the company should do in the future.

Professor John C. Edmunds Boston, Massachusetts 18 Protocols of the Communication, 2 The company does not have to do what minority shareholders and institutional investors tell it to do. But top management must take into account the recommendations and, if it does not follow the recommendations, must explain why it is not going to follow them.

Professor John C. Edmunds Boston, Massachusetts 19 Protocols of the Communication, 3 Top management should do road shows frequently, traveling to financial centers to inform analysts and investors about the company’s progress and about its plans. The style of communication during these road shows is candid and sometimes blunt. Top management must expect this because it is effective and people are too busy to speak euphemistically.

Professor John C. Edmunds Boston, Massachusetts 20 Attributes of Securities that Investors Like Everybody knows that investors prefer securities issued by companies that are growing rapidly, are profitable, and are innovators in “sexy” industry sectors. Your companies have some of those attributes.

Professor John C. Edmunds Boston, Massachusetts 21 Attributes, 2 Your companies, however, are initially at a disadvantage because of where they are based. The countries where your companies are based are high-growth, high-potential and rapidly progressing.

Professor John C. Edmunds Boston, Massachusetts 22 Attributes, 3 The institutional framework is also progressing but is still fluid. People in financial centers like London and New York are skeptical of the checks and balances and regulatory mechanisms in the countries where your companies are based.

Professor John C. Edmunds Boston, Massachusetts 23 Attributes, 4 Your companies will have to show investors that they are serious about delivering returns to minority shareholders and institutional investors. The conventions and regulatory frameworks where you are based will not convince investors. You yourselves will have to convince investors.

Professor John C. Edmunds Boston, Massachusetts 24 Conclusions and Recommendations Companies should focus on selling securities to the public many times, not just one single time. Companies that are successful in raising capital via public issuance put top priority on making minority shareholders and institutional investors glad they took the risk of buying the securities.

Professor John C. Edmunds Boston, Massachusetts 25 Conclusions and Recommendations, 2 Top management should not delegate the job of communicating with minority shareholders and institutional investors. The job is very important and subordinates cannot do it. Consultants can help but cannot help much unless top management is participating actively and providing timely and accurate information.

Professor John C. Edmunds Boston, Massachusetts 26 Conclusions and Recommendations, 3 Companies that make good use of the capital markets can achieve lower cost of capital, can finance rapid growth, and can attract and retain key employees. Managing relations with capital markets is a key determinant of success. This has been true in the industrial countries for over half a century, and now is also true in the emerging countries.