Recently, I spoke with L. J. Rittenhouse, president of Rittenhouse Rankings Inc., a strategic investor relations and coaching company. When I heard about her recent book Investing Between the Lines: How to Make Smarter Decisions by Decoding CEO Communications, I was intrigued by this idea that decoding executive communications can help me pick better investments.
After reading this book I realized that her research and findings go beyond investing. Rittenhouse’s research introduces new, important ideas about strategy, culture, communications, values, and trustworthy leadership. Not long ago, I asked L.J. about how philosophy and research are supported by her work with CEOs and investors.
The Power of Words and Corporate Culture
You have said frequently that, “Words matter as much as numbers in determining the investment potential.” That’s not something I typically hear on Wall Street.
I’m sure you’ve heard lots of pundits boldly predict the future by looking at past historical trends. How many of these predictions came true? Not many. In fact, Warren Buffett has observed that if the future resembled the past, then the Forbes 500 list of wealthiest people would include a number of librarians.
My research shows that while no one can predict the future, we can create the future through our communications. We do this when we choose words that inspire others to imagine new opportunities – and let go of the status quo. This is a critical competency in today’s world. Standing still is not a viable option.
One of the great delusions in business is the idea that words don’t matter. They do. When my clients choose candor over obfuscation, they build reservoirs of trust. In fact, the words a CEO chooses will reveal the trustworthiness of the corporate accounting. This becomes obvious when you understand how financial statements are created.
It starts with company employees who decide how much cash to recognize during a reporting period, and when and where to report it as earnings. These judgments may be conservative, like ones you’d expect at a Berkshire Hathaway company, or they may be aggressive, like Enron’s accounting.
CEOs who rely on jargon, clichés, and confusing statements to explain their strategies will weaken trust and create cultures of fear. Employees will be discouraged from speaking truth to power. Rather than attend to the needs of customers, colleagues, owners and other stakeholders, they will look out for themselves. This increases enterprise risk and destabilizes earnings.
On the other hand, CEOs who adopt a candor standard and choose authentic, relevant words will create high performance cultures. Striving to meet the needs of the company’s stakeholders, these CEOs and employees will execute clearly defined strategies.
Candor as a Competitive Advantage
Let’s go back to Warren Buffett. He’s a master communicator. Many people who don’t even invest in his company read his shareholder letters. Since you’ve studied them at a level most don’t, tell us what characteristics make them exemplary.
Buffett’s letters stand out because: 1) he writes them himself and imagines an audience; 2) they reveal his investor partnership philosophy; and 3) he’s never afraid to say, “I was wrong.”
Buffett imagines he is writing to his sisters, Bertie and Doris. They are intelligent, but not experienced in business. Owning substantial stakes in Berkshire Hathaway, the sisters want to know how the company progressed during the year. Buffett regards them as business partners. This is why he teaches readers of his letters about important concepts that underlie company performance.
Unlike other CEOs, Buffett takes credit for business successes and failures. In fact, Principle 12 of the Berkshire Hathaway Owner’s Manual states that investors can expect him “to tell you the business facts that he would want to know if these positions were reversed.” Why? Buffett believes, “The CEO who misleads in public may eventually mislead himself in private.”
He starts writing his letter in August almost six months before its publication. An early draft goes to Carol Loomis, Senior Editor at Fortune Magazine, who has worked on many Berkshire letters over the years. She sends him back a marked up copy after which, Buffett states, “I start all over again.”
You’ve analyzed thousands of executive communication pieces. Would you share an example that you considered a disaster?
The example below is a potential disaster for the shareholder letter author but a boon for investors. It reveals the CEO’s discomfort about disclosing important information. As well, this story from Investing Between the Lines illustrates how clear, straightforward commentary can quickly morph into F.O.G., or “fact-deficient, obfuscating generalities.”
In 2010, I was asked by a very smart patent lawyer to review mystifying language in the Goldman Sachs 2009 shareholder letter. In this passage, Goldman seemed to deflect accusations it had received preferential treatment in AIG’s 2008 government bail out. Accounting for 40 percent of the letter, this tortuous explanation began with a clear statement of facts:
Since the mid-1990s, Goldman Sachs has had a trading relationship with AIG. Our business with them spanned a number of their entities, including many of their insurance subsidiaries. And it included multiple activities, such as stock lending, foreign exchange, fixed income, futures and mortgage trading.
AIG was an AAA-rated company, one of the largest and considered one of the most sophisticated trading counterparts in the world. We established credit terms with them commensurate with those extended to other major counterparts, including a willingness to do substantial trading volumes but subject to collateral arrangements that were tightly managed.
Suddenly, the passage was obscured by F.O.G. The underlined words below highlight jargon and confusing phrases that signaled corporate unease:
As we do with most other counterparty relationships, we limited our overall credit exposure to AIG through a combination of collateral and market hedges in order to protect ourselves against the potential inability of AIG to make good on its commitments. We established a pre-determined hedging program, which provided that if aggregate exposure moved above a certain threshold, credit default swaps (CDS) and other credit hedges would be obtained. This hedging was designed to keep our overall risk to manageable levels.
As part of our trading with AIG, we purchased from them protection on super-equivalent transactions executed with clients taking the other side of the same trades. In so doing, we served as an intermediary in assisting our clients to express a defined view on the market. The net risk we were exposed to was consistent with our role as a market intermediary rather than a proprietary market participant.
The contrast between this commentary and the earlier paragraphs in the letter was stark. When I asked the patent lawyer why he failed to see this difference, he confessed that he thought he was not smart enough to understand what they wrote.
You encourage candor. But is this realistic? In an age of social media when comments quickly get distorted when presented out of context, don’t leaders need to be more guarded and measured in their communications?
Why Warren Buffet’s Letters Stand Out
1. He writes them himself.
2. They reveal his investor partnership philosophy.
3. He’s never afraid to say, “I was wrong.”
My research shows that in this age of social media, we need more, not less candor. It shows that companies adopting a standard of candor will go beyond the goals of transparent communication.
Consider the derivation of both words “transparency” and “candor.” The root word of “transparency” is PARERE. It means “how things appear” or to “see through.” The root word of Candor, however, is CANDERE and means “to illuminate.” It is the root word for candle. Leaders who value candor strive to shed light into dark places. They gain a competitive advantage.
Why is this so? In today’s fast-paced world, CEOs practicing candor are more likely to get reliable, relevant information from their teams. They can think more intelligently and act more decisively in crises. Candor-savvy leaders will build cultures based on trust.
Much of your work is on written shareholder letters. As we move into a new era of social media, video, and blogs, do you need to expand your study of meaningful executive communications?
I have applied the candor points system to CEO teleconference scripts, speeches, management discussion and analysis reporting, CEO blogs, videos, and of course, social media. Since 2001, my research shows there has been a dramatic decline in context and positive candor in corporate communications.
Your question reminds me of the insights in Neil Postman’s 1984 bestseller, Amusing Ourselves to Death. He argued that the transition from a world in which books are the medium people use to learn about each other, to one where images are supposed to create understanding, would foster trivial, context-less, and ahistorical cultures.
As a champion of written narratives, Postman would have applauded the development of candor analytics to measure meaningful, reliable context in all kinds of reporting. He understood that the decline of context and connection is harmful to businesses and the economy. Why? It weakens trust. And without trust, we cannot expect to have strong businesses, a functioning civil society (necessary in market-based economies) and growing, sustainable economies.
In your book you describe your quantitative methodology to measure context and candor in communications. How do you distinguish between positive and negative candor?
My analytic methodology is based on a point system that rewards companies for providing relevant context in their communications. Over the years, I have identified over 100 strategic topics that were commonly mentioned in letters to shareholders. Creating protocols to search for these topics and then assigning point values allows me to see gaps in CEO communications as well as patterns and trends that are not apparent to others.
I award points for positive candor. For example, a company reporting a qualitative goal to increase ROI, such as “our goal is to increase ROI,” will get five candor points. A company reporting a quantitative goal such as, “Our goal is to increase ROI by 20 percent,” will be awarded 10 points.
Conversely, I deduct points for negative candor including clichés such as, “Our future is bright” or business jargon like, “becoming a solid execution engine.” In other words, I weight words and phrases based on their importance to business success. After totaling all these positive and negative points, I derive a score so I can benchmark companies based on executive candor commitments.
Based on your research, what is the L. J. Rittenhouse view of leadership? What qualities do you look for in a leader?
Let me tell you about a friend who was among several internal and external candidates in the running to become the next CEO of his company. This story showcases a vital leadership quality.
When I asked why he wanted the job – in addition to the money and power – my friend exclaimed, “I want a challenge. I want to go into new businesses and expand into new markets. I want to use what I have learned and to develop new skills.”
These were great reasons, but I kept pressing for more. One day, he declared, “Because I want to restore the company to its greatness.” In that moment, I knew my friend would become the next CEO. By connecting with a purpose bigger than himself, he spoke from his authentic voice. When I search for authenticity in leaders, I look to see if a CEO’s personal purpose aligns with the company’s purpose.
We know about the corrosive impact of inflated egos. When I analyze a communication, I search for words to see if the CEO’s ego focuses on “me and me” or on “me and we.” Arrogant, self-serving, out-of-touch CEOs present a serious financial risk. Leaders with strong egos who make courageous and wise decisions for the greater good will create sustainable, growing companies. Wise investors know the difference.
Your work is focused on investing in a company, but I see many ways your theories can be applied. For instance, if you are looking for a job, decoding these communications could help you in the interview process or deciding whether you want to work somewhere. Have you applied this thinking to other areas outside of investing?
Absolutely. For example, boards of directors can use Candor Analytic findings to measure the quality of corporate governance. My research assists them in succession planning. Over the years, candor scores have predicted which new CEOs are most likely to succeed. Forensic linguistic analysis reveals strategic gaps that alert directors to operational and financial gaps.
Warren Buffett has said that you are still “on the side of the angels.” That’s high praise. Your 2010 book, Buffett’s Bites (which Buffett rated an A+) is a concise guide to the Berkshire Hathaway principles. Would you share one of these principles from Buffett Bites?
Yes, I believe Buffett gave me a high grade because I focused on a vital Berkshire principle: capital stewardship. He has created a business model that allows him to invest capital based on economic, not accounting results. While lots of CEOs give lip service to “long-term shareholder value,” Buffett walks his talk. Each year in his letter, he reports on his now 48-year performance track record (1965-2012) and compares Berkshire’s book value growth with growth in the S&P 500.
Buffett’s late wife, Susie, once called her husband an “innovator,” like Bill Gates. I agree. Buffett’s career shows that it is possible to be a successful capitalist and not a materialist. Sure, he is proud of his shareholder letters (which I consider his greatest legacy). But take a minute and go to the Internet to search for Buffett’s house and his shareholder letters. I did this. To my surprise, I found more results for the “modest” house Buffett has lived in, since 1958, than for his letters.