stock price and business case for compliance

Introduction

Compliance regulations are often seen as taxes and or cost centers for companies. Each time new compliance regulations are passed, lobby groups challenge the regulation’s efficacy, declaring the cost of compliance will result in huge losses along with potential job cuts and subsequently launch court appeals. Is compliance simply a cost center? Can companies that embrace compliance with mandated regulations and rally to put in place in-depth programs compete or do they get left behind by the competitors who either outright avoid compliance or do the bare minimum? If compliance related costs put firms with the most robust programs at a disadvan-tage, should those not playing fair see the greatest impact to their bottom line? Through independent analysis with Watermark Advisors and Vanderbilt Owen Graduate School of Management, an analysis of 100 public Assent Compliance customers was conducted to see if, over a 5-year period, those that invested significantly in their compliance programs outperformed the market (S&P 500).

Summary

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Stock Price and Business Case For Compliance

Stock Price Analysis-5 Year Returns

The stock prices for the selected companies and S&P 500 were obtained via Yahoo! Finance for February 20, 2015, August 20, 2014, February 20, 2013, Febru-ary 17, 2012, and February 19, 2010. All stock prices were adjusted for splits, reverse splits, buybacks, and additional equity issuances. Dividends were excluded from this analysis, so the analysis focused solely on stock prices and the return attributable to the change in stock price from one period to the next.

Time 0 3 Year 4 Year 4.5 Year 5 Year

$100.00 $232.61 $358.80 $343.89 $346.59

$100.00 $132.78 $161.57 $174.62 $185.33

$100.00 $192.31 $272.55 $264.66 $276.56

$100.00 $132.78 $161.57 $174.62 $185.33

$100.00 $148.10 $199.16 $190.43 $193.52

$100.00 $132.78 $161.57 $174.62 $185.33

Top 10 Assent Customers

S&P 500

Top 20 Assent Customers

S&P 500

Customers 100 Public Sample

S&P 500

Cohort Breakdown

The returns were analyzed by assuming an investor put $1.00 into a company covered by the compliance software and $1.00 into the S&P 500 at time t = 0 (February 19, 2010). For each date, the percentage change in per share price is the assumed dollar change in the initial investment. E.g. if a stock increased from $50 at t = 0 to $100 at t = 1, the $1.00 invested at t = 1 would be worth $2.00, a 100% return on investment.

Researched performed independently by Jacob Wrot MBA Vanderbilt University | Investment Baking Analyst - Watermark Advisers

In presenting the chart, the ten companies with the highest five year returns were juxtaposed with the S&P 500. The five year return was selected over other potential time frames to smooth out any short-term fluctuations in a business-cycle, thus yielding a more meaningful measure of long-term performance.

The S&P 500 was chosen as the benchmark for this analysis because of its ubiquity when speaking about large cap U.S. equities. The index includes 500 leading companies and captures approximately 80% domestic market capitalization.

Over the analyzed five year period, the top ten com-panies using the compliance software had an average total return of 247%, equating to a 28% compound annual growth rate (CAGR). Over the same five year period, the S&P 500 had a total return of 85%, which equates to a CAGR of 13%.

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$70.00$60.00$50.00$40.00$30.00$20.00$10.00$0.00

Time 0 3 Year 4 Year 4.5 Year 5 Year

MNTX

TDY

BC

TMO

CFX

HON

SPA

IMAX

HAR

S&P 500

ESL

Top 10 Assent Customers 5 Year Performance

If an investor had allocated $10 to each of the top ten compliance firms ($100 in total), on February 19, 2010, their $100 investment would now be worth $347 compared to only $185 had the investor invested in the S&P 500 over the same time period.

$400.00

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$0.00 Time 0 3 Year 4 Year 4.5 Year 5 Year

Top 20 Assent Clients Versus the S&P 500

Compliance Firms S&P 500

Over the five year period, the top twenty companies using the compliance software have an average total return of 177%, a 23% CAGR. As stated above, the S&P 500 had a total return of 85% (13% CAGR).

If an investor had invested $5 in each of the top twenty performing compliance firms, $100 total, on February 19, 2010, their $100 investment would now be worth $277 compared to only $185, had the investor allocated to the S&P 500 over the same time period.

$300.00

$250.00

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$0.00 Time 0 3 Year 4 Year 4.5 Year 5 Year

Assent Customers 100 Public Sample

Compliance Firms S&P 500

Over the five year period, all of the companies using the compliance software have an average total return of 94% (14% CAGR) compared to the 13% CAGR of the S&P 500.

If an investor had invested $2.13 in each of the companies using the compliance software, $100 total, on February 19, 2010, their $100 investment would now be worth $194 compared to $185 with an investment in the S&P 500 over the same time period.

The Case for Compliance

It is often said that correlation is not causation, and we cannot definitively say there is a departure from that thinking here. Investing in a compliance program does not cause returns to exceed those of the market, but given the evidence above, we cannot discard the idea that investment in com-plaint companies is a profitable strategy when measured against returns of the market at large.

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Additionally, a multitude of latent benefits and positive externalities may result from allocating capital toward a basket of compliant firms.

Companies Investing in Compliance Ensure Continued Market Access

Measured, by GDP the European Union is the most lucrative market in the world. It is also the most heavily regulated market in the world. The RoHS regulation, which largely affects electronic manufacturers, was the first major Restricted Substance List (RSL) that came with a heavy punitive burden for those in breach. This then paved the way for the all-encompassing (all articles and chemicals in scope) REACH regulation. Noncompliance with these regulations means no market access, heavy fines, and jail time if companies are found in breach. The global trend is toward more regulation as developed countries and their consumers place more emphasis on the sourcing of their wares and material constructs. Companies that choose not to invest face loss of market access and should therefore look at their compliance program as mission critical.

The Need for Speed – When New Regulations are Passed

As regulations come with stiffer enforcement penalties and become more prominent in sheer number, firms must be prepared for what is ahead in order to comply quickly with any new regulations coming online. Governments are becoming more attentive and aggressive each year in passing legislation that responds to social concerns of the day – Dodd Frank section 1502 Conflict Minerals being a prime example. The responsibility and burden this places on companies are real and will impact company reputations for those in breach. In a recent (Aug 2014) Compliance Week article titled “A New Breed of Regulations Won’t End with Conflict Minerals” the author identifies where regulators might look next:

Death Metal

A geographic hot spot that could lead to new law or regulations is Indonesia. Tin produced in the region is controversial, not just because of ongoing human rights concerns, but for environmental reasons as well. Recent protests have targeted Apple, Samsung, Sony, LG, and others about the damage done to tropical rainforests from tin mining in the country.

Palm Oil Problems

Palm oil, also produced in Indonesia along with other countries, is another product drawing close attention from activists and could end up on the radar of regulators. Child labor is alleged to be widespread in Indonesia’s palm oil industry. An investigative report by Bloomberg Business Week, published in July, documented evidence of human trafficking, violence against workers, and slavery.

Wood

Certain wood, produced both domestically and abroad, could end up on the list of materials regulators want more information on regarding use and initial source. Where companies get their wood, and how they ensure proper reforestation programs are in place, is a growing concern. Swedish furniture maker Ikea, for example, consumes nearly one percent of the total wood used commercially around the world, making it one of the largest demanders of wood in the retail sector. As such, it has been under increasing pressure from activists to use source products more responsibly. The company, in its most recent sustainability report, insists it has done so.

Cobalt

It wasn’t included in the list of four conflict minerals cited by the Dodd-Frank Act, but many speculate cobalt could be eventually added.


The Democratic Republic of Congo, targeted by the rule, is also the world’s largest producer the mineral. Cobalt is used as a blue pigment in many paints and is widely used as a component of lithium ion batteries. Its strength and durability has also made it a preferred metal in tool construction, notably drill bits, along with artificial joints and limbs.

Dirty Water:

A wide range of other physical commodities could also, rather easily, fall under the regulatory umbrella, including the sourcing of cotton, leather, food items, and even water.

It Doesn’t End There. What about Poor Sourcing Practises?

Factory Conditions: Reports of harsh working conditions and employee suicides at China-based manufacturer Foxconn have been an ongoing PR nightmare for Apple and other tech companies relying on the cheap labor Foxconn provides. Worker safety also came to light, in dramatic fashion, earlier this year when a garment factory collapse in Bangladesh killed 1,129 workers. Following the disaster, many retailers agreed to sign a legally binding European accord requiring retailers to fund fire safety and building improvements at the Bangladesh factories they utilize. A non-legally binding effort spearheaded in the U.S. for its companies has been less successful, with firms like Walmart and GAP citing legal liabilities for their refusal to sign on. Although federal legislation to force an EU type of agreement is unlikely, expect to see shareholder activists push a similar agenda.

Human Trafficking and Slavery: Many U.S regulations can trace their origin to similar efforts that initiated either overseas or in their domestic markets. Potential rules for public companies regarding human trafficking and slavery would be an example of both.

The California Transparency in Supply Chains Act requires many companies doing business in California to disclose efforts they have taken to eliminate human trafficking and slavery from their supply chains. The law applies to retail sellers and manufacturers in the state with annual worldwide gross receipts exceeding $100 million.

In a climate where a multitude of regulations could affect firms of all sizes, those that invest in a scalable compliance program will win the race for market access and favored market status. See “How Apple Increased Its Market Cap by 8 Billion Dollars in 1 Day through Compliance” (below).

When Your Biggest Clients Come Knocking – Will you be Complying?

In the compliance space, it is often the biggest companies who have the largest scope of regulatory burden, but that does not mean SMB’s are exempt or should be less attentive to the compliance landscape. As tier 1 firms invest in their programs, their supply chain will inevitably have to follow suit. Being in a position where a large contract can be withdrawn for noncompliance can be devastating to smaller firms. For businesses who sell to the government, this can also be highly impactful to the bottom line. Say for example your firm is in aerospace and defense. The government is incentivized to uphold regulations it passes or risk being challenged on their logic in passing the regulation. Firms of all sizes and member of all sectors must be cognizant of the notion that when their larger client base invests in a compliance program they will surely expect/demand the same of their supply chain. Investing early is the best solution to avoid business disruption.


Compliance Means Bigger and Better Data:

Firms who invest in their compliance program improve data quality and control. This has direct affects during the R&D phase and a strong compliance program permeates through the engineering department allowing both speed and efficiency in the department. One of the most crippling things to happen for a firm can be conducting a recall due to non-compliant parts. With a robust and developed compliance program firms can help mitigate this financial and PR risk.

8 Billion Dollars In Market Cap and The Business Case For Compliance:

On the day Apple announced it was 100% conflict-tantalum free, the media was quick to pick up the story and Apple was featured on popular tech blogs, the New York Times and dozens of other tier 1 media outlets. (Mashable, Venture Beat, LA Times, etc) . What did this mean for its bottom line? At the opening bell, Apple’s stock price was $535 and come market close, it was $544. Apple had 892 Million shares outstanding. Thus, the resultant increase in market cap was (892 million x $9 =) ~$8 billion. While companies often see compliance and sustainability as simply an expense item, it shows that both Main Steet and Wall Street reward compliant companies. Consumers gravitate toward brands who publicize their compliance and Wall Street rewards them. It seems then that investment into a compliance programs can pay huge dividends. In a recent article published by the National Association for Environmental Management (NAEM) they cite as their headline: The Business Case for Sustainability is Getting Easier To Make. Among leading companies, the concept is widely understood both in theory, as well as in operational terms. These advanced efforts have rippled throughout the entire business ecosystem, spurring new attention to sustainability at all levels of the supply chain.

Broader cultural awareness of sustainability means employees are coming to work with a better understanding of the topic, which makes it an easier sell for those seeking buy-in for their projects. This alignment includes those in leadership roles as well, as sustainability has gone from an abstract external conversation to one that relates to what companies are doing internally. As one Assent customer (included Top 10 category above and with sophisticated sustainability/compliance program) was quoted, “After a few years of watching and listening and trying to understand what was being talked about with regards to sustainability, our team and myself and many of the professionals in our function said, ‘Well that’s what I do. Or that’s mostly what I do.’” Indeed, according to NAEM’s 2012 report on EHS and Sustainability Staffing and Structure, the top programs respondents identified as “sustainable” fall within the responsibilities of the EHS function: carbon foot-printing, setting sustainability goals, energy and carbon management, sustainability strategy, waste recycling, and water efficiency. Regardless of age or size, all companies we spoke with have a strong focus on meeting environment, health and safety, and, increasingly, sustainability regulations. As product compliance, green chemistry, storm water, and cap and-trade regulations come into effect, many of the programs companies are voluntarily undertaking today will be written into the formal regulatory requirements. The risks of non-compliance are easy to quantify, as they are associated with fines, bad publicity, and even losing preferred-supplier status. Compliance also serves as the foundation upon which most sustainability programs are built, as one respondent described, “We believe as a fundamental basis of being a sustainable organization, we need to be compliant with environmental regulations.”


Conclusion:

Data suggests there is an ROI for compliance. In both the B2B and B2C markets, companies who can demonstrate they play fair are rewarded by their customers. This translates to better relationships, increased sales and better corporate governance. All segments of the Assent customer list data set (top 10, top 20 and the list in its entirety) demonstrate that companies who embrace robust compliance programs and automate those processes through software in conjunction with top tier support will beat the street in both the short and long term outlooks. The business case for compliance is clear.

1http://mashable.com/2014/02/13/apple-conflict-free-metals/ http://www.nytimes.com/2014/02/14/technology/apple-says-supplies-dont-come-from-war-zones.html?hpw&rref=business&_r=0

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