Companies’ Perception of Risk From

© 2013 Bloomberg Finance L.P. www.bgov.com | @BGOV

Companies’ Perception of Risk From

U.S. Government Actions on the Rise

TONY COSTELLO Senior Managing Analyst

JUNE 11, 2013

JORGE UQUILLAS Quantitative Analyst Director of Research

ROBERT LITAN

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© 2013 Bloomberg Finance L.P.

CAN THE RELATIONSHIP BETWEEN GOVERNMENT AND

BUSINESS BE MEASURED? HAS IT CHANGED OVER TIME?

Business Government ?

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10-K ‘RISK FACTORS’ OFFER ONE NEW WAY TO MEASURE

THE SIZE OF THE BUSINESS/GOVERNMENT RELATIONSHIP

» Annual report required by the U.S.

Securities and Exchange Commission

(SEC) that provides comprehensive

overview of company’s performance

» Contains three main financial

statements: Income, balance sheet,

cash flows

» Useful document for investors

» Divided into many sections including

“Risk Factors”

What is a 10-K? SEC “Risk Factors” rule

In 2005, SEC mandated that firms report

“risk factors”† in their 10-K filings

» Required for 10-Ks filed after

Dec. 1, 2005

» Must be located in specific section

» Include only risks that are “known

and material”

» “Risk” can be a misnomer – government

impact on a company’s business model

can be positive or negative.

» Common risk factors listed: Market

(macro), competition, customer

concentration, litigation, key personnel,

government and political

* Warren Buffett’s advice to Vanderbilt MBA students, January 2005. Photo: Andrew Harrer/Bloomberg † Item 503(c) of Regulation S-K

“Read lots of Ks and Qs –

there are no good substitutes

for these. Read every page.”*

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BGOV HAS DEVELOPED A UNIQUE METHODOLOGY USING

10-KS TO MEASURE PERCEIVED U.S. GOVERNMENT RISK

1 Selection of industries » Six industries generally viewed to be affected by government in different ways:

• Defense, Energy, Finance, Health Care, Industrials and Technology

2 Selection of companies » Ten companies per industry, 60 total

» Two companies per subindustry* -- one large-cap and one small-cap

• Large-cap is the highest market-cap company within a subindustry

• Small-cap is the lowest market-cap company within a subindustry, with a market

cap of at least $100 million

3 Periodicity » First year: 2005

» Three additional years: 2008, 2011 and 2012

» All 60 companies filed 10-Ks in 2008, 2011 and 2012

» 56 companies filed 10-Ks in all four years

* Bloomberg industry classification system (BICS) industries, excluding Defense. Defense does not have enough subindustries to perform this exercise. Therefore, the top

five market cap companies and the bottom five small-cap companies in the aerospace and defense BICS industry were selected.

4 Measurement of allocation and priority » Absolute word count of U.S. government risk language

» Relative word count: U.S. government risk language as a percent of overall risk

factors language

» Which number risk factor contains the first government or political risk language

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BGOV FINDINGS: GOVERNMENT RISK IS MATERIAL

AND INCREASING IN ABSOLUTE TERMS

1 Government impact is perceived as important » In 2012, for five of the six industries, the average percent of the risk factors section

devoted to U.S. government risk was 25% or greater

2 Absolute growth » The total number of U.S. government-related risk words for all companies evaluated

in this study grew every year:

• 2005: 36,000 words

• 2008: 56,000 words

• 2011: 94,000 words

• 2012: 103,000 words

* For the four companies that were not public in 2005, this comparison was made between 2012 and 2008

32%

27% 30%

37%

27%

15%

Defense Energy Finance Healthcare Industrials Technology

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BGOV FINDINGS: GOVERNMENT RISK IS AN INCREASINGLY

MATERIAL RISK RELATIVE TO OTHER RISK

1 Relative growth in aggregate » U.S. government-related risk words accounted for an increasing share of the risk factors

section words over time

2 Relative growth by company » In 2012, 50 out of the 60 companies allocated more words to U.S. government risk

relative to total risk factor language, compared to 2005*

* For the four companies that were not public in 2005, this comparison was made between 2012 and 2008

19% 18%

25% 27%

2005 2008 2011 2012

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BGOV FINDINGS: ALL INDUSTRIES SHOWED AND INCREASED

RELATIVE ALLOCATION TO GOVERNMENT RISK WORDS

Percent of total risk factor words allocated to U.S. government risk,

2005 vs. 2012*

* Percentages in columns are the average of the five companies † For the four companies that were not public in 2005, 2008 percentages were used

32%

17%

41%

23%

Large Cap Small Cap

23% 18%

33%

21%

Large Cap Small Cap

17% 24%

32% 27%

Large Cap Small Cap

29%

17%

36% 37%

Large Cap Small Cap

13%

28% 23%

31%

Large Cap Small Cap

8% 7% 15% 15%

Large Cap Small Cap

117% 77%

Defense Energy Finance

Health Care Industrials Technology

2005† 2012 Percent change, 2005-2012

27%

37% 45%

19% 91% 12%

23% 112%

79%

12%

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BGOV FINDINGS: COMPANIES ARE MOVING GOVERNMENT

RISK TO THE BEGINNING OF THE RISK FACTORS SECTION

1 42% of the companies have government risk as the first risk mentioned in

their 2012 10-K

2 59% of the companies moved government risk up in the risk factors section:

2012 vs. 2005*

59% Moved up

18% Stayed at #1

5% Stayed constant,

not at #1

18% Moved down

* For the four companies that were not public in 2005, 2008 percentages were used

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BGOV FINDINGS: COMPANIES ARE USING MORE SPECIFIC

GOVERNMENT RISK LANGUAGE IN THEIR FILINGS

A look at government risks for Exxon-Mobil, as an example: 2005 vs. 2012

Source: Exxon-Mobil Corp. 10-K filings

2005 2012

Environmental:

» “Changes in environmental regulations or other

laws that increase our cost of compliance or

reduce or delay available business opportunities

(including changes in laws related to offshore

drilling operations, water use, or hydraulic

fracturing);”

Access:

» “A number of countries limit access to their oil

and gas resources, or may place resources off-

limits from development altogether. Restrictions

on foreign investment in the oil and gas sector

tend to increase in times of high commodity

prices, when national governments may have

less need of outside sources of private capital.

Many countries also restrict the import or export

of certain products based on point of origin…. As

a U.S. company, ExxonMobil is subject to laws

prohibiting U.S. companies from doing business

in certain countries, or restricting the kind of

business that may be conducted. Such

restrictions may provide a competitive advantage

to our non-U.S. competitors unless their own

home countries impose comparable restrictions.”

Environmental:

» “Environmental regulation;”

Access:

» “Restrictions on the Corporation’s ability to

do business with certain countries, or to

engage in certain areas of business within a

country;”

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THOUGH THERE MAY BE AN ALTERNATIVE REASON FOR THIS

TREND, EVIDENCE POINTS TOWARDS INCREASING CONCERN

Evidence in support of

increasing sophistication

Counter-evidence in support of

increasing government concern

Larger absolute risk factor sections do

not explain the significant relative

increase of government-related risk

over time

There is no incentive or rule change

that would encourage companies to

expand this section of their 10-K

» There have been no changes to the

SEC guidelines on risk factors since

2005

» In general, the risk factors section is

intended to highlight for investors

what could negatively impact their

investment

Risk factor sections overall have

grown longer and more specific

Companies are doing more through

10-Ks to protect themselves against

shareholder lawsuits

Since inception of the SEC guidelines in 2005, companies

have become increasingly sophisticated in writing their

10-K risk factors sections

Alternative

Explanation

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SUMMARY

1 U.S. government is currently perceived to have a significant impact on business » Varying degrees of perceived impact, but no industry is immune

2 Company perception of the risk of U.S. government actions has increased

over time » Absolute increase

» More importantly, government risk has grown relative to other risks

3 Higher priority has been given to government risk over time

5 Same trends observed across all industries and size of companies

4 Companies are using more specific language to describe government risks

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APPENDIX

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APPENDIX: RISK FACTOR DATA (1 OF 2)

Note: Companies highlighted in orange represent small-cap companies

Company

2012 2011 2008 2005

Percent of Risk

Factor Words

Devoted to

Government Risk

Number Risk

Factor

Government

Risk First

Mentioned

Percent of Risk

Factor Words

Devoted to

Government Risk

Number Risk

Factor

Government Risk

First Mentioned

Percent of Risk

Factor Words

Devoted to

Government

Risk

Number Risk

Factor

Government Risk

First Mentioned

Percent of Risk

Factor Words

Devoted to

Government Risk

Number Risk

Factor

Government

Risk First

Mentioned

Defense

United Technologies Corp. 32% 1 24% 1 31% 3 24% 1

Boeing Co. 30% 1 30% 1 19% 2 26% 2

Lockheed Martin Corp. 58% 1 50% 1 41% 1 43% 1

Precision Castparts Corp. 33% 2 33% 2 29% 2 29% 3

General Dynamics Corp. 52% 1 45% 1 37% 1 41% 1

National Presto Industries Inc. 37% 6 37% 6 24% 2 29% 1

Astronics Corp. 16% 1 16% 1 15% 13 15% 2

Anaren Inc. 19% 5 11% 4 11% 6 10% 5

LMI Aerospace Inc. 16% 7 15% 7 14% 3 20% 5

Ducommun Inc. 29% 8 26% 9 12% 2 13% 2

Energy

Exxon Mobil Corp. 39% 2 36% 2 9% 2 21% 3

Occidental Petroleum Corp. 24% 4 29% 4 23% 4 7% 4

Schlumberger Ltd. 54% 1 49% 1 24% 1 34% 1

First Solar Inc. 18% 4 14% 2 13% 8 NA NA

Duke Energy Corp. 32% 1 25% 1 27% 1 30% 3

Murphy Oil Corp. 14% 3 15% 3 9% 3 10% 8

Gastar Exploration Ltd. 26% 2 26% 2 13% 5 17% 1

Bolt Technology 17% 3 17% 3 4% 2 9% 2

Green Plains Renewable Energy Inc. 26% 1 23% 6 17% 35 16% 20

Unitil Corp. 23% 1 27% 1 33% 1 38% 1

Finance

Wells Fargo & Co. 32% 2 30% 2 29% 3 21% 8

Berkshire Hathaway Inc. 36% 8 30% 9 7% 9 8% 9

Visa Inc. 32% 1 31% 1 25% 1 NA NA

JPMorgan Chase & Co. 33% 1 32% 1 23% 6 16% 7

MetLife Inc. 25% 1 29% 1 16% 2 21% 2

Farmers National Banc Corp. 30% 1 21% 1 26% 8 21% 1

Eastern Insurance Holdings Inc. 19% 7 19% 8 17% 9 NA NA

First Marblehead Corp. 34% 2 32% 6 25% 16 29% 12

FBR & Co. 20% 12 14% 23 14% 26 NA NA

Phoenix Companies Inc. 33% 1 26% 1 24% 14 23% 11

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APPENDIX: RISK FACTOR DATA (2 OF 2)

Note: Companies highlighted in orange represent small-cap companies

Company

2012 2011 2008 2005

Percent of Risk

Factor Words

Devoted to

Government Risk

Number Risk

Factor

Government

Risk First

Mentioned

Percent of Risk

Factor Words

Devoted to

Government Risk

Number Risk

Factor

Government Risk

First Mentioned

Percent of Risk

Factor Words

Devoted to

Government

Risk

Number Risk

Factor

Government Risk

First Mentioned

Percent of Risk

Factor Words

Devoted to

Government Risk

Number Risk

Factor

Government

Risk First

Mentioned

Healthcare

UnitedHealth Group Inc. 52% 1 49% 1 32% 1 42% 4

Danaher Corp. 29% 6 30% 6 29% 4 30% 8

Tenet Healthcare Corp. 38% 1 25% 1 18% 2 15% 2

Pfizer Inc. 24% 1 24% 1 12% 1 20% 1

Quest Diagnostics Inc. 39% 1 38% 3 37% 3 41% 1

Independence Holding Co. 34% 9 18% 10 14% 3 11% 4

Utah Medical Products, Inc. 42% 1 42% 1 8% 8 8% 8

Five Star Quality Care Inc. 28% 2 26% 2 14% 5 16% 4

Omega Protein Corp. 34% 5 23% 5 15% 5 17% 5

Gentiva Health Services, Inc. 46% 6 48% 12 33% 7 35% 8

Industrials

Fluor Corp. 24% 1 27% 1 19% 11 17% 10

Timken Co. 16% 9 18% 8 19% 9 17% 8

Caterpillar Inc. 26% 2 19% 2 20% 1 0% NA

Vulcan Materials Co. 19% 9 18% 11 9% 5 5% 1

Dow Chemical Co. 30% 5 21% 5 20% 2 25% 6

VSE Corporation 68% 1 73% 1 73% 1 64% 1

Eastern Co. 27% 1 27% 1 27% 1 30% 1

Intevac Inc. 26% 8 22% 7 20% 10 16% 10

Patrick Industries, Inc. 8% 1 3% 13 0% NA 0% NA

KMG Chemical Inc. 26% 13 27% 13 22% 13 29% 3

Technology

Apple Inc. 11% 14 10% 14 5% 14 1% 24

Microsoft Corp. 13% 10 11% 10 18% 7 17% 24

International Business Machines Corp. 12% 8 9% 7 4% 8 4% 10

Intel Corp. 18% 4 17% 4 11% 5 12% 5

AT&T Inc. 20% 2 19% 2 9% 2 7% 3

Radisys Corp. 2% 6 2% 7 1% 13 4% 19

Datawatch Corp. 9% 1 9% 14 9% 14 0% NA

NCI Inc. 49% 1 29% 4 27% 4 19% 14

AXT Inc. 5% 19 3% 1 5% 36 5% 3

Globalstar Inc. 10% 8 12% 5 6% 4 NA NA

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ABOUT THE ANALYSTS

Tony Costello is Bloomberg Government’s Senior Managing Analyst.

Costello spent four years as a buy-side investment analyst covering

energy at Osprey Partners and Mooring Financial, where he evaluated

energy-related securities and made recommendations to portfolio

managers. His undergraduate degree is in finance from George

Washington University and he holds an MBA from The Darden School at

the University of Virginia. He holds the Chartered Financial Analyst

designation.

[email protected]

+1-202-416-3393

Jorge Uquillas is a Quantitative Analyst with Bloomberg Government. He

previously worked at the Antitrust Division of the U.S. Department of

Justice as an economic research analyst performing statistical, regression

and geographic analysis to support antitrust investigations. He holds an

MBA from the University of Chicago Booth School of Business, an M.A. in

economics from The George Washington University, and a B.S. from the

University of Maryland.

[email protected]

+1-202-416-3542

mailto:[email protected]

mailto:[email protected]

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understand the business impacts of federal government actions. For more information,

visit www.bgov.com or call +1 877 498 3587.

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