Corporate Eye

Efficient Markets – Even More on Financial Theory and Investor Relations

The efficient market hypothesis is a key concept covered in finance classes during the first year of business school. Because it is considered a finance concept, you rarely hear it discussed in the context of investor relations, but it has a key role to play.

In its simplest form, the efficient market hypothesis states that security prices fully reflect all available information. The implications of this seemingly simple statement are profound, because if current stock prices reflect all relevant information, then prices will change only when new information arrives. New information, by its definition, cannot be predicted ahead of time, and therefore stock prices cannot be predicted ahead of time, and will be random.

There are actually three versions of the hypothesis: The Strong form, which posits that ALL information, both public and private, is embedded in a security’s price; the Semi-strong form, which holds that all widely available public information is reflected in the stock price; and finally the Weak form, which says that a stock’s price reflects all information that is contained in the past prices of the stock.

Of the three forms, financial economists are pretty much in agreement that the Strong form, that security prices embed all information about a stock, both public and private, overstates the case. If it were true, insider trading would not reap abnormal profits, which it clearly does. Most settle on the Semi-strong form of market efficiency as their preferred thesis. Since Eugene Fama initially wrote about efficient markets in 1969 literally hundreds of event studies have been done showing that markets rapidly react to widely available information.

So, you may ask, what has all of this got to do with investor relations? The key here is that investor relations has a fair amount of discretion over what information becomes widely available. Forget for a moment what you have to disclose because of regulations and quarterly filings and think instead about other things that make up your company.

Just to take one example, think about corporate culture. Nothing in the regulations or disclosure requirements require you to talk about your company’s corporate culture. Yet that very same culture may be a big reason behind your company’s performance and its future prospects. Wal-Mart comes to mind as a company that puts its culture in front of investors by letting them attend Saturday meetings in Bentonville and welcoming them to the extravaganza they have each year at their annual shareholders’ meeting. Another example that comes to mind is quality of a company’s management team. If you don’t get the management team in front of investors so that they can judge how great they are, that information is not widely available and the market will never know about it. If investors don’t know how good the entire management team is, they can’t build that into their expectations of future profits and therefore it will not be reflected it in your stock price.

What you choose to disclose above and beyond the regulatory requirements is entirely up to you. Every company is good at something – sales, brand management, product innovation, distribution or operations, to name a few. Disclosing selected data of this nature with investors can help them more efficiently value your stock. The key is that the information has to be widely available. This means that you have to have a consistent effort to disclose those pieces of information, both in good times and in bad, to all your investors.

Do that, and you will have done your part in making the markets more efficient.

The following two tabs change content below.

John Palizza

John recently retired as a Lecturer in Management at Rice University’s Jones Graduate School of Management, where he taught investor relations. Prior to that, John was in charge of investor relations for Sysco Corporation and Walgreen Co. He holds a MBA from the Kellogg Graduate School of Management at Northwestern University and a law degree from Loyola University of Chicago. You can learn more about John’s thinking about investor relations at his blog, Investor Relations Musings.
 
Comments

No comments yet.

Leave a Reply