by Kenneth M. Eades Professor of Business Administration The Darden Institute for Business in Society (IBiS) held its Strategic CFO Roundtable on 9 January 2014 in Arlington, Virginia. This quarter s Roundtable continued the tradition of the first half of the session being a discussion of the Roundtable Survey results for the quarter. The second half of the session typically features a Top of Mind Topic that serves as an in-depth discussion for the CFOs. For the January 2014 Roundtable, however, we invited Troy Paredes, a former U.S. Securities and Exchange commissioner, who spoke about current issues and trends at the SEC and how they impact business. As the CFOs gathered in the early part of the New Year, there was much to celebrate about the national headlines. Looking back on 2013 we saw an outstanding performance by U.S. equities with the stock market recording a 32% total return for the year. Price-earnings ratios were also up reflecting a certain amount of growth expectation yet to be realized. A buoyant stock market has a number of effects including a boost to corporate defined benefit plans from being around 30% underfunded during the recession to being about 95% funded by the end of 2013. According to JP Morgan, 84% of the S&P 500 equities were paying dividends in 2013, which is the highest percentage in 15 years. If we were to add the number of public companies with share repurchase plans, the percentage of firms returning some form of cash to their shareholders would be even higher. Regarding the stock market, one CFO challenged the group to think about other major segments of the equities market, such as the NASDAQ where the news was less positive: I go back to the dot com days, right? The NASDAQ was over 5,000. And so we re really still hovering around that level. The NASDAQ has really never come back so that was 14 years ago almost at this point. Several CFOs commented on how to use their cash, including one CFO who stated: You can make capital expenditures or you can make acquisitions, certainly I wouldn t say there s any pressure, but we need to do something with those funds. As far as the buy-backs go, we did buy back over the past five years, we ve probably spent 600 million buying back shares. THE SURVEY Prior to each quarterly Roundtable session, we conduct a survey to provide insights into the business views of the Roundtable Members in the Washington D.C. Metropolitan Area relative to their counterparts nationwide. Some of the survey questions are constructed to parallel those of the Duke University/CFO Magazine s Global Business Outlook Survey, which has polled senior finance executives over the past 71 quarters. The survey responses prompted conversation among the Roundtable Members regarding their expectations of domestic and global economic recovery, the financial condition of their own firms and evidence of recent actions for growth of their companies. JANUARY 2014
Economic Outlook The January 2014 Darden IBiS Strategic CFO Roundtable Survey showed a continued level of optimism about the economy that was somewhat below the level reported in September and close to the levels reported in the national survey. The graph below depicts how CFOs rated their optimism about the U.S. economy on a scale of 0 100%. (See Figure 1) Both the national Global Business Outlook and the Darden IBiS Strategic CFO Roundtable Survey showed optimism levels near 60%, which is similar to recent trends for both surveys. The national survey (solid line) dropped slightly from 58% for Q3 2013 to 57% for Q3 2013, while the Roundtable Member CFOs (dashed line) fell a bit more from 65% for the September 2013 survey to 60% for the January 2014 survey. A closer look at the data reveals that only one of the seven CFOs responded below 50%; i.e., to suggest a lack of optimism about the U.S. economy. The rest of the responses signaled various levels of optimism with the highest response being 75%. 80% Figure 1: Optimism for the U.S. Economy (Scale of 0 100%) 60% National Survey Roundtable Survey 40% 20% Figure 2 compares the CFO Roundtable group with the national survey regarding their optimism toward their own companies. Both surveys have consistently reported higher levels of optimism for their own companies relative to the U.S. economy. In particular, on average, our Roundtable Members have reported a premium level of optimism for their own company of about 13% since 2010, compared to an 8% premium reported by the national survey. Our CFOs reported slightly higher optimism levels (dashed line) than the national survey (solid line). A couple of CFOs who gave high levels of optimism for the U.S. economy, reported lower levels for their own companies. Most of the CFOs, however, expressed higher optimism about Page 2 29 January 2014
their own companies with the average being 68%, comfortably higher than the 60% level reported on average for the U.S. economy. Figure 2: Optimism for their Own Company (Scale of 0 100%) 80% 60% National Survey Roundtable Survey 40% 20% Employment Since its inception, the Roundtable Survey has asked participants to estimate the number of months that will pass before domestic employment will return to pre-crisis (year end 2007) levels for the U.S. economy (See Figure 3). The solid line in the graph reveals that Roundtable Members expectations have consistently been between 30 and 40 months for the past couple of years, but the level dropped to 28 months for the January survey. Several of the CFO s responded never for this question and those responses could not be meaningfully quantified to include in the average. Therefore, a reasonable interpretation of the data would best be stated as For those CFOs who believe the U.S. unemployment will eventually return to pre-crisis levels, they expect it to take two to three years. Page 3 29 January 2014
Figure 3: When Will the U.S. Return to Pre-crisis Employment? (Months) 50 40 U.S. Economy 30 20 10 Own Company 0 The dashed line in Figure 3 reflects the Roundtable Members optimism about the employment levels of their own companies. The CFOs have consistently viewed their own company employment levels as much better than the overall economy. For the January Survey, the public company CFOs reported an average of two months for their companies to return to pre-crisis employment levels. Again, however, there were a couple of companies reporting never that were left out of the average calculation. The most common response was zero; i.e. the firm had already returned to the pre-crisis employment level. Despite the limitations created by the never response, it seems fair to say that the Roundtable CFOs see their own company employment as having recovered better than the overall economy since the onset of the recession in 2008. The general topic of employment often spurs a conversation at the Roundtable about various aspects of talent management. For example, one CFO pointed to the role of efficiency regarding employment figures: our company is growing so our head count is up. But if you looked at revenue per person [within our service lines], we ve seen efficiency gains there that, in certain divisions, while they ve grown, they ve been able to grow efficiently and we don t need as many people doing per dollar revenue as we did five years ago. Another CFO commented on the importance of retaining key talent as he described his company s retention strategy: one of the troubles we have is we don t have a lot of middle management at our company. So we ve actually taken strong performers and just put them in completely different roles. And, you know, I think that s been a win for us because you ve taken good people and kept them in the organization and had them do something else. And sometimes you ve even created things for them to do like new lines of business... Page 4 29 January 2014
Top of Mind Speaker Troy Paredes The Strategic CFO Roundtable was pleased to invite Troy Paredes as the Top of Mind speaker. Mr. Paredes was appointed to the U.S. Securities and Exchange Commission in 2008. His five year term ended in the summer of 2013. Prior to serving on the SEC, he enjoyed a highly successful academic career at Washington University School of Law. As a recent SEC commissioner, Mr. Paredes brings an insider s look at the workings of the Commission and his outlook regarding future issues of importance to the SEC. As part of the survey, Roundtable Members were asked to list what they believed should be the top priorities for the SEC in 2014. Although the responses were highly varied, perhaps the closest to a consensus was in the category of simplifying financial statements ; i.e., disclosure rules and interpretation of Dodd-Frank. In addition, Members mentioned: facilitate the ability to raise new equity in markets and minimize new regulations; i.e., less is better. Mr. Paredes began his remarks with a reminder of the uniqueness of his experience at the SEC: it s worth not losing sight of the fact that I arrived at the SEC on August 1, 2008. Enough said, right? So I was at the commission at the peak of the financial crisis and throughout its aftermath. I knew that notwithstanding how busy and stress-filled the peak of the financial crisis was for all of us, including those of us in government, that there was going to be a whole heck of a lot of work, particularly for the SEC and other financial regulators, when the inevitable new round of legislation and regulation came. He carefully explained his views about the role of regulation and the role of government and about the difficulty of getting the right balance between conducting business in imperfect markets and using laws and regulations, which are also inherently imperfect, in an attempt to improve those markets and business conditions. Along a spectrum reflecting the degree of regulation, Mr. Paredes described himself as having serious concerns about the costs of overregulation when undue burdens are placed on business and our financial markets. For example, he noted that the Dodd-Frank Wall Street Reform and Consumer Protection Act as a 2,000 page piece of legislation, would seem almost certainly to be on the too much regulation end of the spectrum. He also pointed out that many sections of Dodd-Frank are unrelated to the financial crisis, such as those provisions requiring the SEC to undertake certain social rulemakings that fall outside the SEC s areas of expertise. The Roundtable Members were interested in Mr. Paredes observations regarding how decisions are actually made within the SEC. On this topic Mr. Paredes emphasized that crafting rules for the markets ultimately relies upon individuals who act on incomplete information that predictably leads to a less than perfect result. The process of gathering input from all interested parties for a given regulatory debate is itself a complex process. A company, trade association or other market participant can submit comment letters that get posted to the SEC s website. Often times these parties ask for a face-to-face meeting with a commissioner or individuals on the SEC staff. As part of the Government in the Sunshine Act, no more than two of the five commissioners can sit down and talk about any given rule under consideration other than at a Page 5 29 January 2014
public meeting. This can make it difficult for commissioners to engage and interact as a group on important policy matters. A theme during Q&A with Mr. Paredes was the assessment of the cost-benefit analyses of legislation. That conversation began with a look back at Sarbanes-Oxley Act of 2002, which Mr. Paredes saw as a prime example of Congress using a one size fits all approach that could have been more efficiently dealt with at the state level, such as Delaware. Delaware state corporate law has tended to favor an enabling approach that provides a great deal of flexibility for how companies address a governance issue. As the Q&A session continued, Mr. Paredes commented on several specific provisions of different legislation including the SEC s proxy access rule, the say-on-pay provision of Dodd-Frank, and the IPO on-ramp provisions of the JOBS Act. Each provision provided the opportunity for Mr. Paredes to outline his approach to cost-benefit analysis, which he supports. As our time with Mr. Paredes came to an end, he shifted his remarks toward thinking about the future for the SEC: Historically, the SEC has not been a data-focused or economics-focused agency. That s changing. I stressed from day one at the Commission that we needed to get more economists, that we needed to get the economists more involved, and that we needed to focus on data. I actually think that the recent changes at the agency hold a lot of promise. Regarding the overall regulatory landscape, Mr. Paredes pointed to the increased focus on economics playing a larger role with the self-regulatory agencies, such as FINRA, PCAOB and MSRB. 1 One of the most important issues for the Roundtable Members identified by Mr. Paredes was how the new financial oversight agencies (FSOC and CFPB) might ultimately define their authority vis-à-vis the SEC and other financial regulators. 2 Regarding the future of financial regulation in general, Mr. Paredes ended his remarks by saying: Dodd-Frank isn t necessarily the last word on any of this. We continue to have elections. And as the makeup of the government changes in Congress, the White House, and in administrative agencies, things continue to change. The 33 Act has been amended over time as has the 34 Act. We ended up getting two 40 Acts years later. So it s not as if [the SEC s] authority is set in stone. We ll have to see how things play out. The Darden IBiS Strategic CFO Roundtable and Private Company Strategic CFO Roundtable will re-convene Tuesday, 18 March, 2014. 1 FINRA is the Financial Industry Regulatory Authority; PCAOB is the Public Company Accounting Oversight Board; and MSRB is the Municipal Securities Rulemaking Board. 2 FSOC was created by Dodd-Frank and is the Financial Stability Oversight Council. Also created by Dodd-Frank, the CFPB is the Consumer Financial Protection Bureau. Page 6 29 January 2014
About the Author Kenneth M. Eades, Professor of Business Administration, is the Chair of Darden Finance Department and serves as the Academic Director for the Darden Center for Asset Management, as well as Associated Faculty with the Darden Institute for Business in Society. The author of more than 50 Darden cases and three books, Eades has received both research and teaching awards. About the Darden IBiS Strategic CFO Roundtable The Strategic CFO Roundtable is a quarterly, invitation only convening of leading chief financial officers in the Washington D.C. Metropolitan Area to discuss, debate and share best practices on enhancing the strategic role of the CFO. With over 300 years of strategic financial and leadership experience, the Roundtable participants share their views on the challenges and opportunities facing their companies. They discuss the lessons learned from triumphs and trials that led to their becoming recognized as strategic CFOs. The Strategic CFO Roundtable is organized by the Institute for Business in Society at the Darden School of Business of the University of Virginia. About Darden Institute for Business in Society http://www.darden.virginia.edu/web/institute-for-business-in-society/ The Institute for Business in Society (IBiS) is a Center of Excellence at the Darden School of Business at the University of Virginia. Its mission is to be a leading global catalyst and convener of thought, information and action at the interface of business and society. To achieve that mission, IBiS brings together the top thinking in business education with industry leaders, regulators and other thought leaders to understand and advance the role of business in providing lasting value and positive impact in an increasingly complex global society. Contacts Jane Scott Cantus, Fellow, Darden Institute for Business in Society; Principal, ILEX Leadership Associates, LLC Jane Scott.Cantus@ILEXLeaders.com / Direct: 703 549 9938 / Mobile: 703 606 6200 Ken Eades, Chair, Finance Department, Darden School of Business Eades@virginia.edu / Direct: 434 924 4825 Dean Krehmeyer, Executive Director, Darden Institute for Business in Society KrehmeyerD@darden.virginia.edu / Direct: 434-924-6060 Page 7 29 January 2014
Darden IBiS Strategic CFO Roundtable Survey Results January 2014 1. Compared to last quarter, are you more or less optimistic regarding:-u.s. economy (Less =1, More = 3) 1. Compared to last quarter, are you more or less optimistic regarding:-financial prospects for your own company (Less =1, More = 3) 2. Rate your optimism regarding: (Drag the slider to assign a number.)- U.S. economy 2. Rate your optimism regarding: (Drag the slider to assign a number.)-financial prospects for your own company 4. Regarding domestic employment, when do you anticipate a return to pre-crisis (year end 2007) levels for the U.S. economy-months 4. Regarding domestic employment, when do you anticipate a return to pre-crisis (year end 2007) levels for your firm-months N = 7 N = 7 N = 9 N= 397 N= 438 N= 453 Public RT Public RT Public RT Jan 2014 Sept 2013 June 2013 Duke Q4_13 Duke Q3_13 Duke Q2_13 Average Median Average Median Average Median Average Median Average Median Average Median 2.4 2.0 2.3 2.0 2.3 2.0 2.1 2.0 2.1 2.0 2.4 3.0 2.4 2.0 2.3 2.0 2.3 2.0 2.1 2.0 2.2 2.0 2.2 2.0 59.6 62.0 65.0 61.0 60.9 62.0 57.2 60.0 58.2 60.0 60.8 60.0 68.3 70.0 75.3 75.0 72.9 80.0 65.5 65.0 65.0 70.0 64.2 65.0 28.5 27.0 40.0 36.0 34.5 30.0 2.4 0.0 12.0 0.0 5.3 0.0 5. How would you rate...-your employees morale level? (Poor =1, Satisfactory =3, Excellent = 5) 4.0 4.0 3.9 4.0 4.0 4.0 Page 8 29 January 2014
Darden IBiS Strategic CFO Roundtable Survey Results January 2014 (Continued) (Weaker =1, No change = 2 Stronger = 3) 6. Recent quarter's financial results vs. previous quarter: -Income Statement 6. Recent quarter's financial results vs. previous quarter: - Balance Sheet 6. Recent quarter's financial results vs. previous quarter: - Cash Balance 8. Expected change over the next 4 quarters vs. last 4 quarters: -Income Statement 8. Expected change over the next 4 quarters vs. last 4 quarters: - Balance Sheet 8. Expected change over the next 4 quarters vs. last 4 quarters: - Cash N = 7 Public RT Jan 2014 N = 7 N = 9 Public RT Sept 2013 Public RT June 2013 Average Median Average Median Average Median 2.6 3.0 2.3 2.0 2.4 3.0 2.4 2.0 2.7 3.0 2.8 3.0 2.4 3.0 2.6 3.0 2.6 3.0 2.8 3.0 2.7 3.0 2.4 3.0 2.5 2.5 2.7 3.0 2.3 2.0 3.0 3.0 2.4 3.0 2.6 3.0 (Reduced =1, No change = 2, Higher = 3) 4 quarters: - Headcount 4 quarters: - Capital Spending 4 quarters: - Compensation 4 quarters: - Pro develop/training 4 quarters: - Prob (new mkt/product) 4 quarters: - Prob (Acquisition) 2.7 3.0 2.6 3.0 2.4 3.0 2.4 3.0 2.4 2.0 2.3 2.0 2.7 3.0 2.9 3.0 2.6 3.0 2.3 2.0 2.3 2.0 2.1 2.0 2.4 2.0 2.7 3.0 2.6 3.0 2.0 2.0 2.4 2.0 2.2 2.0 Page 9 29 January 2014