Carmen Lilly

Hi, everyone, and welcome back to IR and focus.

In the next 20 minutes, we're going to be discussing corporate capital allocation strategies and trends. With me today is my esteemed colleague, Christopher Stroh. Christopher to is an Executive Director and Head of S&P Global Situational Analytics team, which focuses on sustainability, focused ownership and targeting studies, transactional risk and opportunity analysis for companies considering or undergoing strategic changes and scenario focused analysis for S&P's Corporate Bank and Exchange Partners.

Chris also has experience helping investor relations teams to understand the institutional investors they should focus on when preparing for investor days, road shows and conferences while operating as a Director of the Corporate Analytics Team at IHS Marketing Ipreo. Welcome, Chris. Thank you so much for being here. And I'm excited for our discussion today.

But I wanted to just give our listeners just a little level set on the lay of the land and the players when it comes to corporate capital allocation strategies. Could you help me out and help our listeners understand who is typically involved and who executes these strategies across the organization?

Christopher Stroh

Yes, it's a great question. And there really is no one-size-fits-all answer. Usually, capital allocation strategy decisions are kind of made across the board with a lot of different people and teams giving input. Usually, the final decision is made at the highest level, but everything else is really a team effort between the CFO, treasury, finance department, the Board of Directors, obviously.

And then the IR team, their typical function is really giving and receiving feedback from institutional investors. So they're not only the mouthpiece for the corporation, but they also communicate what investors are saying up to their management team and the Board. So they have a lot of insight into what investors are looking for and can give a lot of insight into what strategy they may want to follow in the future in order to not only appease current shareholders, but attract new institutional investment into the stock as well.

Carmen Lilly

Great. And thank you for that. I appreciate giving some context there. And just to kind of jump right into it. we're at the tail end of earnings season. And you hear a lot of corporations within their earnings calls discussing their own capital allocation strategies, what's worked, what they may try next. But from your position of being able to work with corporations day in and day out, what sort of trends are you observing and how companies are allocating your capital or thinking about allocating your capital?

Christopher Stroh

Yes, absolutely. Honestly, trends really differ globally across different regions, different sectors. But here in the U.S. What we've noticed over the last couple of quarters since the markets really started ripping, is that a lot of companies are finding or feeling stronger about their financial position relative to the last several years where, obviously, we're dealing with depressed markets, high commodity prices, inflation, et cetera.

We've seen more companies or we've spoken with more companies that are considering initiating a dividend for the first time due to the strength in their cash flows and their overall position in the marketplace. And that's in addition to already having strong buyback programs that they've initiated over the years. So we've actually seen more companies that are in their growth phase, starting to think about attracting new institutional investment capital by initiating a dividend.

And then obviously, with dividend initiation, you're able to typically get into more income-focused funds or growth in income-focused funds. And there is also a large focus by corporate issuers and IR teams on attracting more passively-managed dollars as well with a specific focus on growth in income and income-focused portfolios.

Carmen Lilly

Yes. So that's super interesting in terms of what you're saying about initiating a dividend. But you did touch on that these trends are somewhat a result of the current macroeconomic environment. So let's just take a quick step back and just kind of unpack that a little bit. So we're currently in a high interest rate environment.

We're looking at inflation numbers softening somewhat at a quicker pace than anticipated which seems to have opened the door for the Federal Reserve to consider rate cuts this summer. I was reading a transcript the other day from a conference that the Atlanta Fed President, Raphael Bostic was speaking at, I'm just going to read you a couple of things that he said here.

A year ago, I had expected that the first cut in rates would appropriately be at the end of the year at the earliest. And he said the acceleration of inflations decline has caused me to pull that forward. And it's worth to note here that Bostic is one of the 12 voting members of the Fed's rate setting committee for this year.

He went on to say it'll probably be appropriate if things go the way I expect to see us to start reduce rates in the summertime. So like I mentioned, a quickening of cutting those rates. So I was wondering more broadly in what ways do macroeconomic factors such as interest rates and inflation or even Black Swan events, how do these things influence capital allocation strategies?

Christopher Stroh

Yes, it's a great question. I'm kind of a history or financial economic history, nerd. So I'd like to put everything into context of the history of interest rates, inflation and Black Swan events, especially since the financial crisis was early in my career. But between the financial crisis and some of the other large macroeconomic events over the last decade and half like COVID, we've typically seen those significant events as a period of significant change in terms of capital allocation strategies and policy across issuers.

Oftentimes, especially most recently during COVID, we saw a significant number of companies suspend or cut their dividends because of the uncertainty of what was going to happen with their cash flows with their business et cetera. In terms of inflation over the last three years, we've seen a lot of companies really get hit by commodity prices. But when we focus in on those commodity-linked industries and sectors like the energy sector, basic materials, et cetera.

They really benefited from that inflation and the ability of the price per barrel or what have you, increasing. So they actually took that opportunity as an opportunity to pay down their debt and delever their businesses. And once they reduce their leverage ratios, they began sort of focus on buying back shares. That is something that we have seen across every bull market company using their strength to buy back shares, initiate dividends, increase their dividends over time.

The real focus should be making sure that everything you're doing is sustainable, in general. With higher interest rates, we've kind of seen that have the opposite impact on sectors that depend on debt or tend to have higher debt levels over time, like real estate, for instance, where they may be having issues or they may not be having issues today, but they may potentially have issues in the future, paying down that debt or refinancing that debt as interest rates stay elevated.

So I guess what I'm trying to say is capital allocation policy kind of changes with the times and is cyclical based on the overall market cycle, interest rates, inflation and any other type of large-scale macroeconomic events, which obviously impact the success or the performance of the overall markets.

Carmen Lilly

And I especially love the point that you made around making sustainable decisions. I know if you remember, pre-COVID, ESG was on the rise, a lot of folks were talking about both the environmental, social and governance factors that play into a corporation. And how that ties in is when we think about ESG and how it's integrated into a corporation.

It's really trying to wrap our arms around what is the risk for a corporation, and is this company sustainable in the sense will it exist 20 years in the future? If not, how are you adapting and doing that risk mitigation there. So I like how you kind of pull that in as a theme that you have to think about when you're thinking about capital allocation.

Christopher Stroh

Yes, absolutely. Because, obviously, ESG and sustainability, it's all about risk mitigation, and it's about all stakeholders, right, both internal, external stakeholders as well as shareholders. And it's about growing the company for the long term, as you mentioned. And what we've seen over the years, especially when focusing on sustainable investors and companies being held by sustainability-focused portfolios is a capital allocation policy plays a large part in terms of how institutional investors feel about companies from a sustainability perspective.

I'm not going to name any names, but one of the largest or one of the most widely held companies by sustainable investors and portfolios a little more than a decade ago was actually a company focused on green energy. And one of the reasons that the sustainability-focused institutional investors and portfolios kind of shied away and sold down their positions in the company is because they levered up to such an extreme level that their business as a whole was no longer sustainable despite the fact that they were growing at a fairly fast rate.

And obviously, they had a green energy impact. Financially, sustainable investing in general is obviously motivated by a couple of different factors. But at the end of the day, the financials of the company and their ability to maintain or continue on is going to be the number one decider on whether or not a sustainable investor or ESG investor will take a position.

Carmen Lilly

Yes. And that reminds me, so I was reading a Deloitte survey recently. So they published a survey where they surveyed business leaders across the globe from a wide range of industry sectors. So they included in mining, in like manufacturing, real estate, pharmaceuticals, health care, the gamut. And they focused on large corporations with an emphasis on publicly listed organizations and large private groups.

But now in this published survey, they state that ESG is no longer an optional extra. And they go on to say that ESG has an increasingly central role to play capital allocation decisions, including as a catalyst for defensive and offensive M&A, climate-related adaptation and decarbonization are by far the biggest ESG priorities for the businesses they surveyed. And a lot of these corporations are developing formal road maps, how to achieve net zero specified date and how to obtain board approval.

They're also looking at targets in such areas as water and electricity usage, general waste reduction and recycled packaging. I think the point I'm trying to get across the area is not just something that was like a flash in the pan in terms of here's a new term that you have to pay attention to. It really is rooted in, again, mitigating risk, making sure your company is sustainable.

But now it's playing a very large, outsized role on how these companies are thinking about integrating those ESG strategies into anything from capital allocation to how they talk about the sustainability strategies with the market and with the Street. So I like how you brought it up pretty naturally in the sense it's here. It's something that corporations have to pay attention to in making decisions.

Christopher Stroh

Yes. And I think it reflects that corporate governance risk, the G in ESG is really focused on the overall company not focused on the social aspects or the environmental aspects, but how the company is governed and run and really any risks of it being run in the future.

I mean, the governance aspects of ESG have existed in terms of risk management for portfolio managers and analysts for decades. I think today, it just has a new name and focus and is being integrated with the S and the G as an overall strategy for the sustainability and the long-term-ness of a company in the future.

Carmen Lilly

I think we're seeing a shift here in the U.S., to be honest with you, much like what happened in Europe, where we're moving from shareholder capital is into stakeholder capitalism and thinking about that. And then turning to investor activism and proxy battle.

So we've also seen an increased focus on ESG strategies coming directly from shareholders. S&P recently published an article looking at investor activism trends and 2023 was another very, very busy year for activists, it was record breaking into 2022, which also was a record-breaking year. And if you look at just at 2023, ESG continues to be a prominent theme and it made up of 82% of the campaign objectives in 2023.

And then I was looking at January's data, so let me pull that up. So a total of 67 campaigns have been launched in January against corporations this year. And then 72% of those were related to ESG themes. So if you could just touch on a little bit, how do shareholder activism and proxy battles impact capital allocation decisions and Investor Relations strategies?

Christopher Stroh

Yes, absolutely. Great question. We actually work with companies, both when they are targets of activists currently, but we also work with companies to help them understand how they might be a target for an active situation in the future. And one of the things we actually look at is the balance sheet and the income statement and try to get a sense of not only how the client or the issuer has performed in the past.

But what does their balance sheet look like in terms of their leverage that they are taking on the cash on the balance sheet, where they stand in the market in terms of returning that capital to shareholders and how they're planning on using their earnings in order to grow the business into the future.

And over the years, we've seen activists, historically speaking, if you could go all the way back to the '80s and corporate raiders coming into a company and trying to get some return from that company in terms of a dividend, a special dividend, a spin out, a carve-out, et cetera. And although corporate raters aren't necessarily a thing anymore, activist in general, still focus in on capital allocation policy and cash on balance sheets.

I think everyone remembers a decade ago when Carl Icahn went after Apple, when they had about $100 billion in cash just sitting on the balance sheet. And they were able to convince the Steve Jobs and the executives at Apple at the time to do a buyback program to initiate a dividend and return some of that cash to shareholders over time.

And if you have a capital allocation policy that makes sense for your business and a well-rounded capital allocation policy that works with the interest of your shareholders and your overall stakeholders. And you're not going out on a limb in terms of debt and your leverage ratio, then it really should work for everyone involved for all stakeholders, both internally within the business as well as externally.

And that would absolutely help avoid any type of contentious situation with a shareholder activist or an unhappy institutional investor. And that's why listening to and having that two way communication with your shareholders is so important to make sure that as you're growing the business and as you are making strategic decisions.

In terms of buybacks, paying down debt, initiating a dividend, M&A, R&D, et cetera, that your shareholders' interest are in line with management decisions and everything is clearly communicated to the Street and any feedback from the Street is making its way to the management team and Board for those longer-term decisions.

Carmen Lilly

Yes, I completely agree. And also, you're just avoiding what I'm sure is a fire drill when you have an activist campaign launched against you. So being able to actively listen and react to what your investors and shareholders are saying before a campaign was launched is definitely in the benefit of the corporation in general. So we talked a little bit about trends and what some corporations are doing.

Some influences on those trends. And so I wanted to get maybe a little bit deeper into some tactical talk here. So how does your group measure success when you go in and you help corporations kind of like you rework, refine and finalize their capital allocation strategies. What do you guys look at? What do you think is success.

Christopher Stroh

The first thing we do is we look at what the company looks like today relative to their current shareholder base. And our goal is really to not only help the company understand who they should be speaking with about their future plans, but understand what their current shareholders are focused on and try to help mitigate that risk along the way.

So as our clients are considering initiating a buyback program or a dividend or increasing either or decreasing either of those, really helping them understand what the focuses are of the current shareholder base from a fundamental perspective, whether they prefer more growth in the company versus a return in the form of a dividend. And then based on the plans or the strategy of the company, helping them understand who they should be initiating relationships with or speaking with upon the announcement of their strategy change.

And identifying how that impacts the overall shareholder base from a net perspective. So identifying the shareholders that are inevitably going to sell out or sell down their positions based on a decision versus the new institutional capital, the new portfolios and funds and strategies that are coming into the company based on a change in that overall strategy. So it's really about getting that net benefit, making sure that the decision you're making and the strategy you're focused in on will have a net positive impact for the overall shareholder base and obviously, the stock overall.

Carmen Lilly

Awesome. And now just to put you on the spot here, getting even more specific, I'd like to close out the podcast with an actional piece of advice for our listeners. So if you zoned out for everything else, what is the one piece of advice you'd give IR programs who are currently working through their capital allocation strategies?

Christopher Stroh

The one piece of advice that I would have is to make sure you're analyzing your current shareholder base and the overall market before you make a significant decision and make sure that your communication with your shareholders is making its way up to the Board. So often, we hear that decisions are made top down from the Board level C-suite level on capital allocation decisions without a real large-scale analysis on the impact of the shares or the stock.

And doing some level of perception work in order to get that qualitative feedback from shareholders and portfolio managers as well as a quantitative analysis to understand how the fundamental change to the company will impact the ability for both active and passive shareholders to hold the stock longer term or buy into the stock is really important in order to understand the net benefit of the strategy or change to make sure that you don't lose out on potential investors in the future with your future strategy?

Carmen Lilly

Perfect. Thank you, Chris. And that's all the time we have. Thank you so much for listening, and special thanks to my guest this week, Chris Stroh. We'll be back next month to take a deeper dive into investor activism until then subscribe and maybe catch up on some pass episodes, most recently, I dug into generative AI, its impact of corporation, then they have an episode on the learnings from Cap28 and the capital markets outlook for 2024. Again, thank you for listening, and have a great day.