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CEOs always want to know how the market will react to new strategies and other major decisions. Will a company's shareholders agree with a particular move, or will they fail to understand the motives behind it and punish the stock accordingly? And what can management do to improve the outcome?
Trying to predict stock price movements is necessary, of course. After all, when stock prices fall, the cost of borrowing and of issuing new equity can rise, and falling stock prices can both undercut the confidence of employees and customers and handicap mergers. Unfortunately, however, most of these predictions are no more than rough guesses, because the tools CEOs use to make them are not very accurate. Net present value (NPV) may be useful for estimating the long-term intrinsic value of shares, but it is famously unreliable for predicting their price over the next few quarters. Conversations with sample groups of investors and analysts, conducted by the company or by investment bankers, are no more reliable for gauging market reactions.
But executives can dramatically improve the accuracy of their predictions. By adopting a more systematic, rigorous approach, corporate leaders can learn to understand individual investors as thoroughly as many companies now understand each of their top commercial customers. It is possible to know such customers well because there are only so many of them. Equally, only a finite number of investors really matter when it comes to predicting stock price movements.
Every CEO knows that when buyers are more anxious to buy than sellers are to sell, share prices rise--and that they fall when the reverse happens. But fewer CEOs know that not every buyer or seller matters in this equation. Our research on the changing stock prices of more than 50 large US and European listed companies over two years (1) makes it clear that a maximum of only 100 current and potential investors significantly influence the share prices of most large companies. By identifying these critical individual investors and understanding what motivates them, executives can predict how they will react to announcements--and more accurately estimate the direction of stock prices.
Armed with these new and solid insights about how critical investors behave in specific situations, executives can make strategic decisions in a different light. Knowing what makes crucial investors buy, sell, or hold the company's stock allows the CEO to calculate what its share price might be after an announcement and to factor this calculation into their strategic and operating decisions. To head off short-term selling, a company could manage the timing, pace, or sequencing of strategic announcements. It could introduce a new management team before announcing an acquisition. It could also test an important new product in selected markets before the nationwide rollout. How will investors react to a merger announcement and what will the resulting share price mean for a deal? How might a spin-off fare in the market? Does the company need to prepare the market or to consider a carve-out instead?
A CEO even has the choice of forging ahead in the face of adverse predictions, using the …