A company’s capital allocation policy is often the most crucial component of both its equity story and of management’s credibility. Deployment of investors’ capital can only continue as long as companies demonstrate an ability to generate attractive risk-adjusted returns, and the policy forms a key identifier for various investment strategies such as growth vs income.
While capital allocation is under intense scrutiny from stakeholders, FGS Global receives consistent feedback that detailed and strategic communication on these is overlooked. Policies are seen as high-level and without clear prioritisation, with management appearing unwilling to commit to defining the trajectory of the company. Management must navigate the fine balance between having a capital allocation policy that is clear and precise enough to inspire investor confidence, while providing the flexibility to endure unpredicted disruptions without shocking the market. And IR professionals are often left to balance internal pressures with investor expectations for clarity and transparency.
Supported by insights from over 260 perception study interviews conducted with investors and sell-side analysts, we highlight five practical recommendations to align with best practice and inspire investor confidence. These include:
Defining your capital allocation policy – the importance of being earnest
Vague or generic language can be interpreted as a signal of low conviction or an attempt to avoid detailed discussion. At a minimum, the policy priorities as well as sources and uses of capital must be clearly communicated to all stakeholders, and the rationale fully explained. It is not enough to just show the order of preference; companies must justify this by showing alignment with the strategy, and any targets should align with these priorities.
Announcements on corporate actions and the power of repetition
When announcing any corporate action, such as M&A, it can be extremely helpful to link this back to the existing strategy. This allows you to reiterate key selling points of the company and the investment case. Of course, it is important to accompany this with sufficient evidence that the investment is value accretive.
Getting ESG right – making the connection to return on capital
It is beneficial for any major investment decision to be accompanied by transparency on how ESG was factored into the process. Companies can also highlight how capital allocation into ESG related projects creates value for shareholders, for example by explaining how they can create or deepen a competitive advantage, be at the forefront of innovation, position the company for regulatory change and shifting market demands, or reduce the likelihood of stranded assets.
Building credibility by tracking evidence of success
Building investor confidence starts with establishing a track-record of success, and for key elements of your policy, showcasing this track record will support credibility. There are many means to achieving this, for example by hosting dedicated events for investors to showcase products and innovations.
What to do when things don’t go to plan – say it as you see it
Delaying communication of negative news to the market and doubling-down on the old positive narrative until the issues become unavoidable only adds to investor frustration and reduces credibility. The key is to be transparent in the face of unforeseen circumstances. In such situations, it is helpful for companies to have a very good understanding of key shareholders, their concerns and priorities through proactive and consistent engagement.
A good capital allocation policy explicitly defines what the company stands for and helps set expectations for the future. This is supported by clear and consistent communications and announcements that tie back to core principles and the corporate strategy.