Trust is earned when companies establish a track record of successful execution and when they are transparent with investors on not only specific capital investment initiatives (such as developing a new product line, making an acquisition, or improving data capabilities), but are transparent with their investment selection process and how they strategically allocate capital. According to Doug Giordano, senior vice president at Pfizer, “if investors see you as prudent stewards of capital…they will give you more of an opportunity to invest for the long term.”
In October 2017, Honeywell announced two divestments, worth almost US $7.5 billion in revenue. CEO Darius Adamczyk explained that the review process that led to the decision was “objective and fact-based, involving extensive analysis and input from industry experts and participants, as well as from our shareowners.” He added that “the foundation of the announcement was a set of criteria…against which each business was measured”. By strategically optimizing the business with the divestitures, Adamczyk said that he was excited to invest in any of the company’s four remaining platforms.
The company’s thorough analysis earned broad praise, particularly from a prominent activist investor who was especially pleased with Honeywell’s detailed portfolio review.
The reaction from the activist investor demonstrates how detailed analysis, combined with effective communication, is fundamental to building trust between a company and its investors.
By adopting a high level of discipline around how capital allocation decisions are made, C-suite, board and investor stress can be significantly reduced, and trust among key stakeholders significantly improved.
Eight leading practices for allocating capital
The book, The Stress Test Every Business Needs, published by EY, offers guidance on how to create a cohesive approach to capital allocation through eight leading practices.
- Focus on a small number of metrics that reflect an outside-in perspective and tie directly to creating shareholder value.
- Employ consistent evaluation criteria and objective processes for all investment decisions.
- Establish a “cash culture” that prizes cash flow and does not tolerate unnecessarily tying up capital.
- Take a zero-based budgeting approach to deploying capital.
- Practice continuous improvement by examining each investment and implementing lessons learned.
- Embed stress testing across capital allocation to strengthen resilience.
- Align capital allocation, strategy, and communications.
- Maintain information systems that generate granular data.