Disclosure and Transparency – Too much of a good thing?

What constitutes sufficient disclosure in an organization?  Are we being transparent enough?   Is there a meaningful difference between the two?  I think there definitely is, but these are not easy questions to answer.  At the Bedford Central School District (where I am on the Board) we are unfortunately still paying the price of past sins of insufficient transparency (and perhaps inadequate disclosure as well) even though under the leadership of Superintendent Jere Hochman, the District has made concerted efforts and tremendous progress over the past few years to provide full disclosure and appropriate transparency.  On its website our District provides a fairly thorough and accurate picture of its operations.  If we bombard the public with a plethora of additional reports and educational techo-jargon, then I believe we will merely confuse and not inform.

As a Board member, I still get complaints regarding our lack of transparency.  We will probably be damned if we do and damned if we don’t and it is hard to determine what exactly is the right amount of disclosure that will lead to transparency that will satisfy almost everyone.  At the other end of the spectrum, one can imagine a flood of information that leads to an information overload that can obfuscate the real picture and make it more difficult to form an accurate picture of what is really going on.

We face the same conundrum in the private sector as well.  In private equity and venture capital, there are significant calls for additional disclosure and transparency by CFA Institute and other organizations.  Some of these demands are warranted since limited partner investors in private equity and venture capital funds should be entitled to financial information regarding the performance of their investments.  Indeed, our firm discloses information to its limited partners regarding portfolio company investments, but we specifically indicate that the information that we provide is confidential and not to be disseminated further.  Moreover, we do not disclose information of such a sensitive nature that, if disclosed, would materially damage our portfolio investment or subject us to liability.

Limited disclosure of such financial performance should not pose a serious burden, but more extensive disclosure (especially confidential information regarding portfolio companies) will not necessarily improve transparency materially and may cause harm.  Indeed, knowing that deep, detailed analysis may be disseminated may discourage private companies from even becoming portfolio companies of firms that adopt overly broad disclosure policies.  The law of unintended consequences almost guarantees it.

Private companies are private for a reason and often do not wish to air their laundry – dirty or otherwise.  They choose to operate with the relative freedom afforded by the private markets and accept the capital constraints of these markets in exchange for these freedoms.  Calls for greater transparency are very well and good, but let us keep in mind why many companies choose to remain private and balance their needs with the needs of investors.  Private Limited Partner Investors certainly need to know how well their investments are performing financially, but do they really need to know which big sales deals the companies lost last quarter?  I suggest this information crosses the line for even the underlying principals of the CFA Global Investment Performance Standards (GIPS) “Fair representation and full disclosure.”

No matter how transparent one tries to be, there will always be gaps in information flows and comprehension among parties.  Individuals do not have an unlimited capacity for grasping information in a relatively short time frame nor in many circumstances do they desire complete transparency.  In this way, information is inherently asymmetrical.  It is this asymmetry that enables the above market returns in many markets – especially private ones.  Therefore, call me a heretic, but I believe we should settle on what are reasonable limits for disclosure and transparency and then embrace the rewards.  

Would Newt Pay the OB/GYN for Arnie's Love Child?

I know many will perceive the following as heresy.  Nevertheless, I believe the comments made by Newt Gingrich this past weekend were more important than the revelations disclosed by Arnold Schwarzenegger regarding his heretofore hidden love child.  Yes, I actually believe what I just wrote.  I don't always agree with them, but Gingrich’s comments reminded me of the serious debate that is occurring across this country and the parlous state we are in due to the level of our healthcare spending and the results we get for it.

Healthcare Benefit Costs are the boa constrictors that are slowly squeezing the life out of the companies that we are trying to build in the United States and are choking the state and municipal governments in America.  We feel the pinch in our portfolio companies at my firm.  Moreover, the Hay Group released a report for the Bedford Central School District that I serve that demonstrates alarming annual required contribution numbers.  Our district is accruing liabilities at a terrifying rate and we must change the system or…either the taxes to support the current system will crush us or the costs of doing business through providing traditional healthcare benefits will.  The situation is not all that much different for traditional, low deductible “Cadillac” healthcare plans in the private sector.  They, too, have simply become unaffordable.

I am revisiting a topic that I touched upon back in February when I began a discussion regarding Healthcare IT.  Getting a better handle on how, why and where we spend our healthcare dollars is an excellent idea and mapping spending and tracking procedures, regimens and outcomes is both good business and good science.  Nevertheless, unless and until we move away from a third party payer system except for catastrophic illnesses, we will not make any real progress on costs.  The current situation presents nightmarishly bad incentive structures.  Physicians recommend diagnostic procedures and treatments to patients (everything under the sun to avoid liability) and patients usually accept whatever is recommended because they are not paying for anything beyond the deductible or co-pay amount, which is the responsibility of the insurance company or the government under traditional plans. 

No matter how good we get with any healthcare IT analytics systems, we can never overcome this horrible incentive structure.  All experiments that try to tweak the healthcare system in some way without fundamental reform will ultimately fail.  The only solution that will work to reduce ever escalating costs is for the patient ultimately to have control over the payments to be made to the physician.  The patient will then have a strong incentive to shop for the best physician at the best price.  The debates should be over the amounts and the mechanisms of allocating and transferring funds to the control of the patient.  Patients would then be free to purchase high deductible plans of their own choice, pay directly, or even purchase supplemental private plans.  Since not everyone will be able to afford insurance, there must be consideration of the level of taxation necessary to cover those who cannot afford high deductible, catastrophic insurance and some type of health savings account for regular or preventive care.  It is not fair or a good use of resources to have indigent patients clogging up emergency rooms.   Such facilities would then not be available when truly needed.  If our country were to move in this direction, I believe it would be a system not unlike the one used in Singapore today and it would cost much less than what we spend on the private and public side in the United States. 

Empowered and informed patients are better patients and better consumers and they save companies money.  Their care is equal or better than their counterparts’ at companies with traditional plans.  The Cigna Choice Fund Experience Study simply cannot be ignored. Yes, we can all argue that such a study is self-serving.  But that is far too simplistic an analysis and unnecessarily dismissive.  The logic and the incentive structure behind the Cigna Choice Plan is too compelling to ignore and it is time to move toward a system with a high deductible health care plan and something akin to health savings accounts and that these are funded for those who cannot afford them.  We can do this as companies and as a nation or become less competitive, more highly taxed and poorer.  The choice is ours.

Even with the Triumph of Hope Over Experience, it's still a Buyer's Market

The recent GDP advance estimates for the first quarter of 2011 reinforce what I (and probably many others) have thought was the case for some time.  Economic conditions have indeed improved over the past two years, but not enough to enable us to adopt the Candide philosophy that everything is fine in this best of all possible worlds.  Our economy is gradually digging itself out of the gigantic hole we created, but there are many forces holding us back from crawling out more quickly.  I have been told several times recently that Mergers and Acquisitions is one area that has greatly improved and is helping the country repair itself, but even there, we are not, in the words of the bard Prince – partying like it’s 1999. 

It is true that companies are paying bankers to do deals and are not firing multitudes of employees when they purchase other firms.  I am currently responsible for 6 companies within my firm’s portfolio.  Many of these companies have improved their economic performance substantially in the past two years and are now in various stages of the M&A process.  The M&A market is far better than it was in the very dark days of late 2008 to early 2009 when it was hard to get a meeting with a potential acquirer much less an offer.  But no matter what companies may hear from M&A bankers today (a naturally optimistic lot compensated by doing deals which remain the perennial triumph of hope over experience), it’s still a buyer’s market.  There are a multitude of reasons for this situation and it manifests itself in a number of ways.

For example, it remains the exception and not the rule that a target company can actually get two or more potential acquirers to engage in a formal process bidding against each other and drive up the acquisition price.  There are very few companies like GroupOn that can spurn offers and seriously contemplate going public.  The whiff of an auction causes such angina among corporate development officers at strategic buyers today that they rarely hang around for more than a second round of bidding if they will even go that far. Few targets are so strategic and irreplaceable that acquirers simply must have them.  Therefore, potential acquirers often do not bid up prices much during a sales process.  Moreover, in almost all market sectors, because there are far fewer public companies today than there were 10 years ago, there are typically only a handful of real, potential strategic buyers.  And all of these buyers know one another and are often in fairly regular communication at conferences and other venues.  Debt is expensive and accordingly financial buyers are at a significant disadvantage during such times.  Even though there is talk that the IPO window has recently opened, very few companies offer a credible threat of an IPO and the data demonstrate a relative dearth of public offerings relative to the pre-bubble 1990s.  Accordingly, buyers demonstrate bidding discipline and it is difficult to break down their resolve.

Once a target company has settled on a suitor and has signed a letter of intent to be acquired, the real fun begins. At this stage, the parties have negotiated relatively few provisions that end up in a Definitive Agreement or the very important schedules that accompany a Stock or Asset Purchase Agreements.   Due to a relative paucity of alternatives, buyers hammer target companies on terms and conditions in final legal documents.  For example, escrows are significantly larger percentages of deals than a few years ago and are lengthening.  Representation schedules are enormous and growing and buyers’ initial positions on warranties are ludicrous.  Providing a warranty for the GDPs of the G20 group of countries for the next 3 years would be easier than some requests I have seen.

So what can a company do to protect itself?  I see two choices.  Don’t play the M&A game until power shifts toward sellers.  Few companies have this luxury.  Unfortunately, I don’t see a power shift happening for a long time given the current regulatory and economic environment.  The other choice is to arm oneself with the very best legal, accounting and consulting counsel necessary to combat the arguments that will inevitably come from buyers.  In the end, targets must be prepared to say “No” if the terms and conditions are simply too onerous to bear.  Walking away may be the only choice that will bring buyers to their senses and back to the table.  Such a threat cannot be a bluff because it may indeed be called.  This isn’t poker where one gets to play a different hand with a new set of cards with the next deal.  A target willing to play the walk card must play the same hand it holds in the current economic game.  And it has to be willing to play these cards after a buyer knows a lot more about the company.

In the meantime, let us hope our leaders will make the changes necessary to provide a more fertile environment for economic growth.  And let us hope that buyers will feel more buoyant and demonstrate a greater willingness to spend to seek growth through M&A.  The former will help drive the latter.  I am ready to party again like it’s 1999.  I hope I don’t have to wait a decade or more for another seller’s market party, however.