BT: Meeting management a waste of time? (11 Nov 2006)

Business Times - 11 Nov 2006

Meeting management a waste of time?

By TEH HOOI LING
SENIOR CORRESPONDENT

IN Dresdner Kleinwort Wasserstein analyst James Montier's 100-page report on the seven sins of fund management last year, the third sin is: Why waste time listening to company management?

He puts forth a number of reasons why he thinks talking to management does not help investors make better investment decisions.

First, managers are just as biased as the rest of us, he says. He quotes the Duke Survey of chief financial officers in support of this claim. The survey is carried out every quarter and covers around 500 of America's major companies. The average company has sales of US$2.3 billion and half are listed.

One of the questions the CFOs are asked is how optimistic they are on the economy and on their own companies. According to Mr Montier, in every case, managers were more optimistic about their own company than they were about the economy as a whole. 'This is a classic case of illusion of control driving overconfidence,' Mr Montier says.

In the earlier days of the Duke survey, CFOs were asked if they thought their stock was undervalued by the market. On average 63 per cent thought so, while 32 per cent thought their stocks were correctly valued. And - get this: At the peak of the Internet bubble, nearly 90 per cent of CFOs of tech companies were of the opinion that their stocks were undervalued.

The problem does not just lie with the corporate managers. It's with us as well. Human beings have a tendency to look only for information that happens to back up their current view. Not only do we look for information that agrees with our belief, we also pretty much see all information as consistent with our prior beliefs.

Mr Montier says the classic example of this biased assimilation is a study by Leeper, Lord and Ross. A group of 48 students - 24 in favour of capital punishment and 24 against - were asked to read the same studies on the deterrent efficacy of death sentence, and criticisms of those studies.

Asked what they thought of the studies, those who started in favour of the death sentence thought the studies that supported capital punishment were well argued, sound and important. They also thought that the studies that argued against the death penalty were all deeply flawed. Those who held the opposite point of view at the outset reached exactly the opposite conclusion.

Both groups felt that their stance on capital punishment - be it in favour or against - strengthened after reading the exact same studies.

In the case of investors, chances are they already have a view on the company when they go to meet the management. And it is likely that instead of searching out the disconfirming evidence, they interpret all information provided in the light of their previous view, says Mr Montier.

This tendency is made worse by the fact that 'company management always tell you what you want to hear'.

Not only do we have to contend with this tendency to look for information that agrees with us, and our bad habits of biased assimilation, we also have to be aware of our marked tendency to believe what we are told by people in positions of authority, writes Mr Montier.

He alludes to the experiment conducted by Stanley Milgram in the 1960s where subjects were asked to administer electric shocks to a 'learner' at the instruction of a 'teacher', a person in a white coat and carrying a clipboard. The subjects were told that they were involved in a study on punishment effects on learning and memory.

A subject would sit in front of a box with electric switches marked from 'slight' up to 'danger severe' and 'XXX'. When a button was pressed, a buzzing sound could be heard.

In the classic experiment, the subject couldn't see the person to whom they were apparently administering shocks, but they could hear them. At 75 volts, the 'learner' grunts. At 120, he starts to complain. At 150, he demands to be released and at 285 volts, he gives out an agonised scream. At 425 volts, a grim and deathly silence greets participants.

The experiment was conducted in various countries, from the US to Germany to Australia. In the original study in the US, up to 62.5 per cent of participants pressed the 'XXX' button at the instruction of the 'teacher'. Subsequent studies found 85 per cent being obedient to the highest level of shock in the US, Italy and Germany. It was as high as 92 per cent in Holland and 90 per cent in Spain.

'This is the power of authority ... the more god-like the management, the easier it will be for them to influence analysts who cover the stocks,' says Mr Montier.

After having to watch out for our own psychological flaws, there is still one more hurdle. Can you tell the truth from a lie?

If management is intent on lying to you, can you tell?

An experiment was conducted where serving prisoners were asked to confess to their genuine crimes and crimes they had not committed. Video and audio tapes of the confessions were then viewed by 61 students and 57 professional investigators with an average of 11 years of service. On the whole, be it professionals or students, whether it was the video or audio tape that was reviewed, the accuracy rating was 53.9 per cent - not much difference from a pure chance performance.

The study also found students to be more accurate than professionals, the latter have a higher incidence of false alarm. They assume most people to be guilty. It was found that both groups performed better on the audio than on video tapes.

In another experiment, students were given training in the most common methods of deception detection. The findings: confidence increased with training and experience but accuracy did not.

Indeed a friend who has abundant dealings with top management of companies said she has been 'smoked many times before' and that despite her experience, she has yet to master the skill of telling whether someone is telling the truth.

So where does this leave us?

'Given that we can't easily correct these biases, perhaps company meetings are best avoided,' says Mr Montier.

Well, I still believe there is value in meeting management.

For one thing, you can understand from a manager the industry his company is in. Then you listen to his strategy and what he plans to do as part of his strategy. From there, you can then critically assess if you think the strategy is workable in the context of the industry and what competitors are doing.

And I believe that one can get 'vibes' - be they positive or negative - from a person through face-to-face interactions. Your life experiences will tell you if you are a good judge of character or not. Of course nobody can be 100 per cent right about a person 100 per cent of the time. But if you are right 80 per cent of the time, that's already not a waste of time.

So perhaps based on the biases mentioned above, someone who is very grounded and not carried away by how smart or good he or she is, someone who has great intellect and a little - but not too much - cynicism, someone who has a little rebellious streak, someone who is able to pick up only the relevant information, someone who has an open mind, and someone who is a good judge of character would make a good analyst.

That's a tall order, and chances are if a person has all the above qualities, he or she wouldn't be recognised as a 'good analyst' in the market. He wouldn't believe that he is able to see the future better than others, and would not be confident enough to have a 'buy' call with a target of $3 with the stock at 50 cents. And without such bold calls, the broking firm that employs him cannot earn commissions, and he will soon be out of job.

Perhaps he might be able to do better in a traditional or hedge fund or managing his own money.

Meanwhile, Mr Montier's other six sins of fund management are:

- Our insistence on relying on forecasts when it has been proved time and again that we simply cannot forecast.

- The illusion that more information is better information.

- Thinking that you can outsmart everyone.

- Being short-term focused.

- Believing everything you read.

- Believing that group decision-making is better.

So ultimately, if one were to start questioning everything - what management says, that one's own forecast cannot be trusted and that one cannot outsmart others - then the only logical investment choice would be to buy into an index, which incidentally is a good option.

As for the stock pickers among us, the list then acts as a reminder to constantly check against our own biases.

Copyright © 2005 Singapore Press Holdings Ltd. All rights reserved.