21 Rules for Young Professionals

You just broke into the workforce as a professional.  Your first real job in the real world.  It won’t always be easy to navigate, or obvious what to do.   This list of timeless rules can serve as a guide to anyone hoping to survive their first foray into the life of a young professional.

1.       Understand failure
It is a thing that will happen.  Be prepared for it, and be prepared to learn from it.

2.       Embrace criticism
There’s nothing worse than seeing a person pout after they receive negative feedback.  You’ve just been given an opportunity to get better, use it. 

3.       Live outside of your comfort zone
Hate public speaking? Look for opportunities to speak in public.  No good at writing? Start a blog. 

4.       Stay humble
Everything that you have achieved up to this point is great, but it means a whole lot less if you start to act entitled.  Let your results speak for themselves.

5.       Have confidence in your work
There may be times when you feel like you have no idea what you're doing, but you landed in your role because someone trusted your ability to figure it out.

6.       Be reliable
There's no substitute for being on time, and being prepared.  Whether it's a meeting, a presentation, or drinks after work, show up on time and be organized.

7.       Become an expert in your field
School's over, and the skills you need for your job won’t always come from your education in the classroom.  Taking the initiative to master your role  can be the difference between a job and a career.

8.       Invest in your appearance
A professional appearance means a lot more when you’re 25 and don’t have ten years of workplace performance to back you up.  Nice clothes, shoes, and a haircut are all good places to start.

9.       Keep your work area clean
Whether you are in an office, a cubicle, or working out of your apartment, people can see your workspace and it reflects directly on your professionalism.

10.   Under promise, over deliver
Doing what you say you will do is one of the straightest paths to credibility.  No amount of education or connections will be able to overcome the damage of failing to follow through.

11.   Use your network, and let it use you
Who you know can make a world of difference, especially when you’re starting out.  Ask for help, ask for introductions, and be prepared for people in your network to ask you for the same.

12.   Handle yourself appropriately in social situations
It’s ok to have drinks with colleagues, even a few, but people never forget the time you make a fool of yourself.  One rough night can be a career limiting move.

13.   Always maintain your integrity
Compromising yourself for any short term gain is not an option, it will be outweighed by the repercussions and become a permanent part of your reputation.

14.   Be a great teammate
Help, support, and encourage everyone that you work with.  Whether they are peers, superiors, or interns, everyone is working toward the same goal.

15.   Manage your online presence
One of the first things someone will do when they want to know about you is Google your name.  Clean up Facebook (or make it private), put some time into your LinkedIn, and be responsible on Twitter.

16.   If you don’t know the answer, admit you don’t know
Honesty defines credibility, ignorance will dig a hole you can’t crawl out of.  Telling someone that you will get back to them with an answer will be understood and appreciated.

17.   Get your hands dirty
If you’re asked to do something, do it.  Nothing is below you at this point in your career, and you will learn something from every task you complete.  If you’re stuck doing paperwork for a week, get really good at doing paperwork.

18.   It’s ok to start small
No matter where you start, it will be your persistence, patience, and consistent effort that will lead you to success.

19.   Learn from your mistakes
You will make mistakes, it is normal and acceptable. Mistakes only become problematic if you make the same ones multiple times.

20.   Own your mistakes
When something goes wrong, deflecting responsibility makes your trustworthiness and dependability evaporate.

21.   Be a good person
Everything else in this list is moot if you’re not a good person, and being a good person is the best networking you will ever do.  Help people, volunteer, say thank you, leave a tip, and hold the door open.  You never know who is watching.

Contributors to this post:

@theaearl (Shopify)

@simonwlove (Ernst & Young)

@Marius_Felix (Brentwood College)

@beesureman (CBRE)

@MaxLanePWL (PWL Capital Inc)

The theory and practice of corporate finance

This paper is a discussion of the findings of a survey that received responses from 392 CFOs.  The survey allows the surveyor to gain insights into subjective areas of interest in corporate finance, including the methodology used by these practitioners for Capital Budgeting Methods, estimating Cost of Capital, and Capital Structure.  I will discuss the survey’s finding in each category and how they relate to the theory that I have learned.

In gaining an understanding of how practitioners approach capital budgeting, the survey asked participants about their usage of net present value, internal rate of return, adjusted present value, payback period, discounted payback period, profitability index, and accounting rate of return.  The results showed that 74.9% of CFOs always or almost always use NPV, and 75.7% of CFOs always or almost always use IRR.  Large firms, firms with high debt ratios, dividend paying firms, and public companies were more likely to use NPV and IRR.  After the NPV and IRR, the payback period was most widely used; it was found that CEOs without MBAs, Mature CEOs, and CEOs with long tenure were more likely to use this method.  It is inferred that the use of the payback period method is caused by a lack of sophistication.  This data is consistent with what has been taught in the business courses that I have taken.  NPV and IRR tend to be strong methods for capital budgeting as they take the time value of money into account and they both allow the project to be compared to other available investments.

The next survey section asked participants three question about how they calculate their cost of capital.  The first question asked how firms calculated their cost of equity; CAPM, average historical returns, or dividend discount model.  The second question asked about the risk factors used, and the last question determined how these models are used once they are constructed.  It was found that CAPM is the most common method of estimating the cost of equity capital with 73.5% of respondents stating that they almost always or always use it.  The next most common methods were average stock returns and a multibeta CAPM.  Large firms are much more likely to use the CAPM, and small firms are more likely to determine their cost of equity directly from investors.  Public firms are much more likely to use CAPM which makes sense as it is difficult to accurately determine a beta for a private firm.  Additional risk factors that are used in calculations include interest rate risk, exchange rate risk, business cycle risk, and FX risk.  Large firms are more likely to adjust for FX risk, business cycle risk, commodity price risk, and interest risk.  Small firms are more affected by interest rate risk.  Interestingly, most firms with overseas sales would use a single company wide discount rate to evaluate a project. (58.7% of respondents), and 51% of firms said that they would use a risk adjusted number.  Large firms were found to be more likely to match their discount rate to the appropriate risk of the project than small firms.  The likelihood that a firm with foreign exposure will use a company wide discount rate is surprising as they are more likely to have projects with varying risks.  The use of CAPM as the main method for determining the cost of equity is interesting after learning about the three factor model.  The differences in the way that firms behave could be attributed to them not fully understanding the risks that they are exposed to when they are selecting projects.  It is also important to note that firms are often not aware that it is dangerous to select projects or evaluate divisions using a company wide cost of capital.

The final section of the survey discusses capital structure; there were numerous questions in this section and I will only discuss the ones that I found to be most salient.  The participants were asked about the corporate tax advantage of debt and it was determined that it is only moderately important in capital structure decisions.  The tax advantage was considered most by large, regulated, and dividend paying firms.  It was determined that firms do not see it as important to maintain a target debt/equity ratio; firms will use the most beneficial form of financing at a given time rather than trying to maintain a set ratio.  Firms do tend to issue stock when prices are high and they will delay issuance in the event that their stock is undervalued.  If a firm knows that they have a high credit rating, but are currently labelled with a low rating, they will not issue short term debt to bridge the gap as was hypothesized by Flannery, Kale, and Noe.  To the contrary of this finding, it was found that firms do try to time the market by timing beneficial interest rates.  When considering issuing new equity, earnings dilution was the most important factor affecting the decision by participating firms which is contrary to what is often taught in business school.

The results of this survey were enlightening as they offer insights from practitioners into the academic theories that are posed by the people that study behavior and data.  Often times, academic theory will not agree with what is true in practice; one of the most interesting parts of this study was that it offered reasons as to why the theories did not hold true in practice.  In many cases, outdated models or methods were used by executives of small companies, older executives, and executives that did not have MBAs.  This shows us that when best practices are not followed, it may be due to a lack of knowledge rather than the academic theories being incorrect.

(Link to paper)

Value destruction and financial reporting decisions

This article is a discussion of a survey of senior financial executives that was carried out by Graham, Harvey, and Rajgopal.  The survey was administered through multiple media and received an overall response rate of 10.4%.  The questions were designed to probe the executives’ thoughts and opinions on how likely they or their firm would be to destroy value in pursuit of short term financial performance.  The categories that the questions addressed were: the importance of earnings, earnings benchmarks, meeting earnings benchmarks, failure to meet earnings benchmarks, sacrificing value to meet earnings benchmarks, and smooth earnings.  

The cash flows that a company produces are what investors are really purchasing when they invest in a company.  This knowledge is not reflected in the sentiment of CFOs.  The survey showed that nearly two thirds of respondents believed that earnings are the most important metric in the eyes of outside stakeholders.  It was noted from the data that unprofitable and younger firms tended to favor cash flows, and private firms were also more likely to favor cash flows.  The fact that public companies are more likely to see earnings as the most important metric may speak to the pressure that financial markets place on companies to perform.  The authors speculate that earnings, particularly EPS, is seen in the eyes of senior finance executives to be important to outside stakeholders because it is comparable across companies and it gets media coverage.  The use of this one single metric also makes it easier for analysts to make predictions on future performance.

As earnings are the most widely accepted performance metric, there are numerous methods for benchmarking.  The idea of earnings benchmarks allows managers to compare their performance to something; the survey showed that the most important benchmark was same quarter last year with a 85.1% of respondents selecting this.  This answer was unexpected as CFOs also stated that missing the analysts estimates leads to the biggest drop in share price, but it was also noted that current quarter compared to last year is the first item in a press release.  The next category addressed the importance of meeting earnings benchmarks; 86.3% of respondents believed that meeting benchmarks builds credibility with the capital markets, with 80% agreeing that meeting benchmarks helps maintain or increase the firm’s stock price.  According to survey responses, individual managers strive to meet benchmarks to maintain their own personal reputation.  Maintaining employee bonuses and lowering the cost of debt were seen as unimportant. 

When asked about the consequences of failing to meet their benchmark, 80.7% of CFOs cited the uncertainty about future prospects and the perception that there is something unknown wring with the firm as the top two consequences.  The CFOs commented on how businesses ore often run in such a way that they will produce smooth earnings with goals that will be perpetually attained.  CFOs are scared of what the market will infer about their company is a target is missed.  In order to avoid missing a target, it was found that 80% of CFOs would decrease discretionary spending on R&D, advertising, and maintenance to hit their earnings target; this is clearly short term behavior that is destroying shareholder value in the long run.  These actions are a quick hit play to maintain the share price, but will undoubtedly have consequences.  Taking it even further, 55.3% of CFOs would delay starting a project to meet earnings targets, even if the delay was clearly going to destroy value.  This data indicates that managers are willing to sacrifice cash flows for accounting earnings.  It is speculated that these actions are the result of managers preferring real economic actions over accounting games to meet earnings due to fear from previous scandals.

Smooth earnings paths are another area that CFOs tend to be willing to make sacrifices for.  96.9% of respondents stated that they prefer smooth earnings, even though the underlying business may be far more volatile.  The reason for this is to make investors think that the company is less risky than it may actually be which can result in lower costs of capital due to a lower perceived risk premium.  CFOs in the survey stated that they would sacrifice value to maintain smooth earnings.

The fact that executives manipulate their earnings numbers to maintain or improve their stock price is scary in the context of maintaining the integrity of capital markets, but when they are willing to destroy long term value to make their performance appear to be strong, that is detrimental to a market where people feel that they are able to trust available information.  Missing the analysts’ earnings consensus and having volatile earnings are said to have similar effects on share price, and are therefore equally avoided even if real value needs to be destroyed to make that happen.  In the context of building and maintaining integrity of the markets, CFOs do a major disservice by placing retail investors at the bottom of the list when they produce their financial information.  Companies do this because it is thought that analysts are young and they will overreact if they see things like volatile earnings, so they are hidden.  It is also noted that because institutional investors are evaluated against each other, if earnings are missed and one fund begins selling off stock, the other in its peer group will likely follow.  Also, hedge funds may have measures in place to sell a stock if it drops below a certain price, and a missed target could trigger the same and a chain reaction following.

In order to solve these problems, the authors propose that firms change their reporting habits by moving to principles rather than rules based accounting standards, remove quarterly EPS guidance, and less emphasis on quarterly earnings.  They also state that it is important to maintain integrity in reporting, and some major changes in corporate governance.  I think that the most interesting suggestion is that of making institutional investors take a more active role in how management perceives their short term actions will be received.  If major funds confirm that they will not sell off a stock due to a missed target as long as there is a value creating activity behind it, managers would not be so short term in their behavior.  I think that although a good idea, it would be very difficult to sufficiently empower retail investors.

(Link to paper)

An academic classic, on the folly of rewarding A while hoping for B

In Kerr’s paper, An Academic Classic, On the Folly of Rewarding A While Hoping for B, he discusses how humans often set up systems that do not encourage the behaviour that is actually desired.  One of the examples that I found to be interesting was that of soldiers in Vietnam versus soldiers in World War Two.  The way that the soldiers were being rewarded in WWII was with the knowledge that if the war is won, they will go home; in Vietnam, the end of the war was not well defined and soldiers had to stay to fulfil their tour of duty no matter what was going on.  The difference in these rewards was the cause of the difference between the disciplined and obedient WWII soldier and the mutinous Vietnam soldiers.  In both of these cases, the Generals were hoping that their soldiers would be obedient, but only in one case were the goals of the soldiers in line with the goals of the Generals.    The same principles apply directly to agency issues where managers may be compensated in a way that rewards behavior that is really the opposite of what the company needs for sustained performance.   The errors in this area are summarized by Kerr; in business we hope for long-term growth and environmental responsibility while rewarding short term (quarterly) results.  It is expected that employees will employ teamwork, but they are rewarded for individual performance.  Employees and managers are expected to report bad news early and exercise candor, but they are rewarded for reporting good news and agreeing with their superiors.  In this same light, executive compensation can be a point of contention for managers and shareholders alike.  It is one of the greatest embodiments of agency issues as executives work extremely hard in order to increase the value of their company while also expecting to be rewarded for their performance.  If they are not paid enough they will take their skills to a competitor, and if their skills have been deemed worthwhile the shareholders will want to keep them.  In Rappaport’s article, New Thinking on how to link Executive Pay with Performance, he discusses some innovative ways to avoid compensating executives handsomely even when they are not delivering.  The idea of indexed stock options eliminates executive compensation being extremely high when the market is up and low when the market is down and instead requires the company’s stock to outperform the market (or a designated index of competitors) to make exercising options worthwhile.  This strategy has multiple effects on executives’ behaviour.  As Kerr says, when managers are not performing the way that they should be it may be time to evaluate the behaviors that are actually being rewarded; the company may not be rewarding what they think they are rewarding.  If managers were receiving options in a bull market, they would not necessarily need to be performing well to exercise their options and receive generous compensation.  In this situation they could easily become complacent while their pockets continued to be padded by the rising market.  Indexing stock option compensation also has the merit of being more valuable the longer those managers hold the options relative to a fixed price option; this also makes managers want to stay with the company longer.  Although this solves some problems for executive compensation, operating managers are not able to partake in this scheme.  Operating managers in charge of business units are less able to influence the price of the overall company’s stock and it would not make sense for them to be penalized for the poor performance of other departments if they have performed well.  Haspelagh, Noda, and Boulos go into these issues in further detail in their article It’s not Just About the Numbers, they refer to it as value based management (VBM).  This style of management focuses on people first, and expects the numbers to follow, and it does not only focus on senior executives.  Just as it was noted by Kaplan and Norton, it is vital for the entire organization to buy into this type of management for it to be successful.  Business units and their operational managers are structured into value centers with strategic goals in line with the VBM program that has been implemented by the overall company.  In order for this to be successful it is necessary to keep the accounting behind the VBM simple, clearly identify value drivers, integrate VBM budgets with the strategic goals of the company, and ensure that they are able to properly manage the performance data that is being produced.  With all of this being said, it is very important for corporate managers to communicate their actions not only across the company, but also to shareholders.  When everyone is used to having their eye on the stock price and short term metrics like EPS, it may be difficult for executives, operational managers, and employees to carry out truly value creating activities.  The example of PepsiCo’s CEO Indra Nooyi announcing restructuring that would reduce profits shows the current disconnect between perception, rewards, and actual value creation; she had fallen out of favor with the board of directors, and the financial media was predicting a meltdown.  Nooyi’s persistence in pursuing a value creating plan that she knew would work in the long term while appearing like a bad idea in the short term proved to be successful.  This is a true example of a CEO doing B despite being rewarded for A.  If executive compensation, and performance measurement at all management levels, is going to truly drive value for shareholders it has to take a long-term strategic approach.  This is not an easy task, but as the business community begins to realize that long term value destruction is caused by the short term performance measurement and compensation structures that are currently commonplace, there is a strong chance that new measures and a more strategic approach will continue be implemented.