How to Build — and Maintain — Relationships with Your Shareholders

Welcome to HBR on strategy case studies and conversations with the world's top business and management experts hand selected to help you unlock new ways of doing business. Does your company have a strategy for working with Wall Street? Whether your company is big or small, IBM's former CEO Sam Palmisano says it's essential to build relationships with your shareholders or before there's a specific problem to address. In this episode, you'll learn how to communicate with your investors to meet their needs without changing your strategy. For instance, when Paul Massano was leading IBM, he offered investors detailed multi year projections of revenue growth rather than quarterly outlooks because he wanted to keep the company's focus on the longer term. You'll also learn how Palmisano carefully considered his role as CEO in meetings with investors in order to send the right messages to IBM shareholders and his employees. This episode originally aired on HBR IdeaCast in May 2014. And just a note, we recorded this by phone. While the audio quality isn't great, the conversation is. I think you'll enjoy it. Here it is.

Welcome to the HBR ideacast from from Harvard Business Review. I'm Justin Fox and I'm talking today with Sam Palmisano, the former CEO of IBM. I did an interview with Sam for the June issue of HBR titled Managing Investors. He also has a new book out, A Path to the Future. Sam, welcome to IdeaCast.

Justin, thank you for having me.

Sam, I came to your office a couple months ago to interview for our magazine about the challenges as a CEO of dealing with Wall street. And I kind of expected you to gripe a lot. But you didn't. Why not?

Well, I think quite honestly, Justin, maybe in my early years as a CEO, I would have been complaining, but I kind of came to the conclusion over time that fundamentally Wall street and the investor are your owners and you need to come up with a strategy to kind of work as best you can with the investment community.

And early on as CEO, was that a problem?

Well, I think quite honestly, as I learned it was an IBM problem, not necessarily Wall Street's problem. We were too confusing to them. And so therefore we found we needed to give them something that worked for us and our management system and our strategy, but also was simpler and clearer so they could decide what investments they would like to make.

So what did you give them?

Well, fundamentally I was opposed to doing short term outlooks. I mean, quarterly forecast down to 100 million of revenue or a penny a share, et cetera, et cetera. I was against that primarily because they felt that it sent the wrong signal to the company and to the people in the company relative to what we needed to work on for the long term. So we came up with a model that was multi year. We rolled it out in 2006 with a target of 2010. But we gave them specifics so they could see how much was going to be revenue growth, how much would be acquisitions and productivity, how much would be share buyback, et cetera, so they could look at the model. We were at $6 at that point in time. We said we would take it to 10 by 2010, and we overachieved and did that by 2009.

That's earnings per share, right?

I'm sorry, Earnings per share, correct, Exactly. But it was something that was long enough for us. Four years was a reasonable timeframe for what we needed to do and also was clear enough for the investor to decide whether they would participate in the company or not or just go invest elsewhere.

And you started doing regular meetings with your biggest investors, right?

Yes, we did, Johnson, that's correct. What we decided to do, we had a long discussion internally. Once we got comfortable with this roadmap, we had a long discussion and it went along the lines, well, if we had an activist involved, what would we do? And I said, well, of course we'd meet with the activists and go through our strategies and solicit their input. So I convinced or persuaded my team that if we would do that for an activist, why shouldn't we do that for a larger shareholder? So we kicked off meetings with the large shareholders and some of the mid tier shareholders, but we'd have a couple of those at one time. We tried to do that in the middle of a quarter when we weren't in a period of quiet period around earnings and those sorts of things.

And your biggest shareholders are mutual fund companies, people like that.

Berkshire Hathaway is the largest capworld and all their funds probably are number two today. Although I'm out of date. I've been retired for a couple of years. But you'd have Fidelity, you'd have Wellington, you'd have T. Rowe Price, you'd have a lot of the large institutional investors were the biggest shareholders of IBM.

And Berkshire came in right at the end of your tenure, right?

That's correct, my last year.

And that was to some extent a reward for your whole plan having worked out pretty well.

Now, Ginny spent a lot of time speaking with Warren after he went public on the investment. So I spoke with him briefly, but she was the new CEO. We all Agreed that she should go make the introduction, spend more time with him than me since I was leaving. But the point was that he understood. I mean, he never invested in tech historically, but he understood the model, he understood the balance sheet, he understood cash flows. He viewed us as a very shareholder friendly company. And that's why he made an investment in a tech company, which heretofore Warren never did. And he stated publicly he didn't understand technology and that's why he didn't invest in it.

When you think about the regular relationship between CEOs and CFOs in Wall street, the thing that comes up is those conference calls, the quarterly conference calls that companies do. IBM does those conference calls, right?

I mean, we sort of have to, right? You announce earnings, you have to have a call. It's mostly the sell side on the call, but the investor and the buy side do listen in.

But are you ever on those calls?

No, I never did those my entire time as a CEO.

And was that sort of matter of principle or.

Well, it was back to. We had a large shareholder meeting in the spring, which I believe IBM still does, and it'd be well attended from both the buy side and the sell side. And. And most of the questions, at least in the large audience, would come from the sell side, similar to a quarterly call. I just felt that it was the. Again, back to the tone it would set internally within the organization. And if I was going to spend the time on that call, it would set the impression that the most important thing we were doing in the company was a quarterly outlook, which, I mean, clearly we performed. So the stock, I think I started it was in the 80s and I left it, it was around 200. So you take that plus share buyback and dividend. We created over $140 billion of shareholder value. There were lots of ways to create shareholder value other than doing quarterly conference calls as you announced earnings.

You had one thing going for you on that decision, which is that your predecessor, Lou Gerstner, didn't do those calls either, right?

Yeah, that's a good point, Justin. I never faced a situation where Lou did it, so I wasn't under the gun or I wasn't breaking the pattern. I think it's harder if you take over as a new CEO and your predecessor did the quarterly call. It's much more difficult to stop because you signal something. It's probably never what you intended, but it's not a positive signal to the investor if you stop doing the call. If your predecessor had done that, it is amazing.

To me, just how many CEOs do those calls? But to move on your approach, this model and the way you communicated with investors, is this something that you think can work for, for any company, or was there something particular about IBM that made that appropriate?

We were one of the first to do, I think we were the first to do it and we couldn't find anybody else that was doing it at the time anyway, or at least a large cap company. We couldn't find anybody that had taken that approach. So we kind of came up with our own model. I believe it can be done. You have to do a lot of work to understand clearly one where you'll be in time. I mean, because you're making lots of investments along the way and then secondarily, how you can explain that to an investor so it relates to the things that they consider important from an investment strategy. I mean, this approach will never appeal to a money manager who's just trading stocks or you know, a fast trader, what have you. I mean, it's not that type of a strategy. So it's not going to appeal to people that take a very short term orientation. However, it does appeal to a long term investor. So you need to one, figure out your business. Are you comfortable with going out four or five years out and secondarily, will that work with the people who hold your shares? Now those two things converge for IBM, I don't know. They would converge for everyone. If you have a high multiple on your stock, a high PE ratio, I mean, you have a lot of momentum players in there, they're probably not going to care about your long term cash flow models. However, if you have a more reasonable valuation, you have longer term investors. Those things become very important.

Now, one phenomenon that existed when you're CEO but seems to be an even bigger deal now, is these hedge fund activists who come in and say they're not happy with the direction management is taking. Do you think that's a bad thing, a good thing?

I'd say it depends. It can be disruptive if the approach the activist takes is one that's more personalized and not necessarily one that represents the collective thinking of the shareholder. However, the other side of that argument is that if the activist is really just talking about capital allocation and return to the shareholder, and takes an orientation which is, hey guys, you're sitting on a lot of cash, why don't you give some back to the shareholder? There are lots of ways to create value other than just doing large acquisitions or strictly driving only the top line. There are other financial models that are relevant to us. And let's discuss capital allocation. And then a lot of times, if you stand back from the rhetoric or from the media coverage and you kind of analyze what some of the activists are really discussing or pushing for, it really is capital allocation, which is something.

You think CEOs should be thinking hard about anyway.

I mean, at the end of the day, the CEO and the board work for the shareholder. And if capital allocation is in the interest of all your shareholders, not just one vocal shareholder, then clearly you should be respectful of that and listen to their input. As I say, listen to their input. You'll get divergent points of view, whether it's dividend or share buyback or acquisition. But we found it helpful, at least I did personally as a CEO, to listen to the large shareholder. In fact, even within a firm, their portfolio managers will take a different perspective. Some will want dividend, some will want share buyback. But it was a worthwhile discussion for us to have. Then we could pass our own judgment as to what was the right mix, where we needed cash, flexibility alike and alike, or should we do this type of acquisition versus another. But we did that. I mean, obviously not sharing any information that was inside information, but we did it in a way that helped at least shape my thinking. I think Mark Lockridge, our cfo, would say the same thing. They really were helpful in getting us to think through the elements of cash flow and balance sheet and how to best return the earnings and the gains to the shareholder.

Well, your book Rethink is kind of. It's a description of this idea of the global enterprise, but it's also the story of how you went from this guy from Baltimore to the head of a global enterprise.

Well, that's right. Well, they need a color. I co author, this guy, Matt Reese, said we have to have some color in here. People are going to find it so boring if you just talk about corpor and globalization and business process. I mean, it's going to be really dull. So I compromised. For the first time in my 40 years in business, I said, I'll talk about myself. But I only did it for one chapter, and that was that. So, you know, I'm not big on talking about myself. I guess you probably sense that.

Sam, thank you so much for talking to us and not just listening.

You're welcome. It would be quite boring if I just listened. You did all the talking, right, Justin?

Right.

That was Sam Palmisano in conversation with Justin fox on the HBR IdeaCast. Palmisano is the author of the book A Path to the Future. We'll be back next Wednesday with another hand picked conversation about business strategy from the Harvard Business Review. If you found this episode helpful, share it with your friends and colleagues and follow our show on Apple Podcasts, Spotify, or wherever you get your podcasts. While you're there, be sure to leave us a review. We're a production of the Harvard Business Review. If you want more podcasts, articles, case studies, books and videos like this, find it all@hbr.org this episode was produced by Ann Sanney and me, Hannah Bates. Ian Fox is our editor. Special thanks to Maureen Hoke, Audie Ignatius, Karen Player, Ramsey Kabaz, Nicole Smith, Ann Bartholomew, and you, our listener. See you next week.