October 18, 2018
Over the last several months, the debate surrounding guidance and reporting requirements of public companies has intensified, drawing comments from numerous political figures and high-profile CEOs. Specifically, much focus has been aimed at whether short-term guidance and quarterly financial reporting encourage management teams to focus on achieving short-term performance targets at the expense of long-term value creation. A recent global survey reveals that companies’ exacerbated focus on short-term financial results is a concern for close to 90% of the investment community. Pundits refer to this as “short-termism.”
For public companies, it is paramount to provide investors with the appropriate level of information necessary to value companies and track their progress. However, there is no one-size-fits-all solution when it comes to guidance or deciding on the optimal reporting frequency. In the following paper, we review previous changes to guidance and reporting practices in the United States as well as the United Kingdom to help shed some light on the various issues at stake.
The practice of providing formal guidance gained popularity in the 1990s, and even more so after the enactment of the U.S. Securities and Exchange Commission’s (SEC) Regulation Fair Disclosure in 2000, which was aimed at preventing select disclosure of earnings guidance and other material nonpublic information.
The debate around public companies disclosing quarterly guidance has gained interest in recent years and was recently resurfaced by Jamie Dimon and Warren Buffet in a Wall Street Journal op-ed published on June 6, 2018, encouraging all public companies to move away from quarterly earnings per share (EPS) guidance.
“I’ve seen how pressure to produce forecasted results distort business decisions in a myriad of ways. Companies, shareholders and, indeed, our country would be better served by focusing on concrete metrics and fundamentals rather than pre-emptive commitments to short-term performance.”
– Warren Buffett, Chairman and CEO of Berkshire Hathaway
They delivered their message in association with Business Roundtable, an organization making up nearly two hundred Chief Executive Officers. According to Business Roundtable President & CEO Joshua Bolten, “an outsized emphasis on quarterly earnings per share projections undermines the importance of investments in infrastructure, workforce development and other crucial capital expenditures that drive sustained U.S. economic growth.”
This initiative builds upon the Commonsense Corporate Governance Principles developed in 2016 by business leaders including Berkshire Hathaway CEO Warren Buffett, BlackRock Inc. CEO Laurence Fink, J.P. Morgan CEO Jamie Dimon, General Motors Co. CEO Mary Barra, and ValueAct Capital Management LP founder Jeffrey Ubben.
“Companies should frame their required quarterly reporting in the broader context of their articulated strategy and provide an outlook, as appropriate, for trends and metrics that reflect progress (or not) on long-term goals. A company should not feel obligated to provide earnings guidance – and should determine whether providing earnings guidance for the company’s shareholders does more harm than good. If a company does provide earnings guidance, the company should be realistic and avoid inflated projections. Making short-term decisions to beat guidance (or any performance benchmark) is likely to be value destructive in the long run.”
– Commonsense Corporate Governance Principles
In its 2018 Policy Statement on Guidance Practices, the National Investor Relations Institute (NIRI) recognized that providing quarterly EPS guidance has become less prevalent since 2008, noting that “an undue focus on short-term, single-point guidance is undesirable and that all relevant audiences – primarily investors, financial analysts, and the news media – are better served when companies focus their guidance on the business’ long-term strategy and value drivers.”
According to NIRI’s 2016 Earnings Process Practices Research Report, 67 percent of survey respondents (largely public company IROs) stated their company provided annual guidance, only 29 percent provided quarterly EPS targets, and 20 percent provided long-term (greater than one year) EPS estimates. Interestingly, a survey from the CFA Institute found that 46 percent of market participants (largely buy-side investors and sell-side analysts) preferred financial guidance for annual periods, compared to 25 percent for quarterly periods, and 24 percent for long-term periods, with no significant differences between buy-side and sell-side respondents.
Overall, while studies have shown the lack of correlation between guidance and shareholder returns, they highlight the increase in analyst forecast dispersion and the decrease in forecast accuracy when companies stop providing quarterly guidance. Companies that stop providing guidance may also experience a decrease in analyst coverage.
The SEC required annual reporting in 1934, semi-annual reporting in 1955 and quarterly reporting in 1970. President Trump’s tweet to the SEC on August 17, 2018 has reopened the debate on the appropriate frequency of financial reporting.
“In speaking with some of the world’s top business leaders I asked what it is that would make business (jobs) even better in the U.S. “Stop quarterly reporting & go to a six-month system,” said one. That would allow greater flexibility & save money. I have asked the SEC to study!”
– President Trump’s Tweet
In response to Trump, SEC Chairman Jay Clayton said in a statement that the SEC’s Division of Corporation Finance “continues to study public company reporting requirements, including the frequency of reporting,” and most recently declared that the SEC “is in no rush to change quarterly reporting requirements for large public companies.” The SEC’s Investor Advisory Committee had noted in June 2016 that “the current degree, quality and frequency of disclosure for U.S. issuers overall is appropriate and a source of strength for the U.S. capital markets.”(13)
Hillary Clinton also took public stances against “quarterly capitalism” in the past, declaring “Everything is focused on the next earnings report or the short-term share price. The result is too little attention on the sources of long-term growth: research and development, physical capital and talent.”
In an effort to combat excessive focus on short-term performance encouraged by activist shareholders, law firm Wachtell, Lipton, Rosen & Katz called on the SEC to consider allowing U.S. companies to do away with the obligatory updates, suggesting that they distract executives from long-term goals.
However, not everyone shares the same opinion. While Jamie Dimon and Warren Buffet are calling for the end of quarterly earnings guidance, they specifically mentioned this should not be misconstrued as opposition to quarterly and annual reporting. They believe that “transparency about financial and operating results is an essential aspect of U.S. public markets” and “support being open with shareholders about actual financial and operational metrics.”
The Council of Institutional Investors (CII) believes that public companies should continue to report their financial performance quarterly. In response to President Trump’s tweet, CII Deputy Director Amy Borrus declared, “Investors and other stakeholders benefit when regulations ensure that important information is promptly and transparently provided to the marketplace. Investors need timely, accurate financial information to make informed investment decisions.”
In The Washington Post, former U.S. Treasury Secretary Larry Summers recently said, “Reducing the frequency of corporate profit reporting would make major surprises and drastic market moves more likely. It would also allow managers to wait longer before they revealed major problems.”
In its 2004 Transparency Directive, the European Commission announced that by early 2007 all European Union member states had to require their public companies to issue Interim Management Statements (IMS) on a quarterly basis.
However, in its 2013 amendments to the directive, the European Commission stipulated that listed companies in member states are no longer required to publish quarterly financial information, but rather can publish semi-annual reports instead. The revised directive states, “In order to encourage sustainable value creation and long-term oriented investment strategy, it is essential to reduce short-term pressure on issuers and give investors an incentive to adopt a longer-term vision. The requirement to publish interim management statements should therefore be abolished.”
As a result, the U.K. dropped its quarterly reporting requirement in November 2014 to encourage more long-term thinking in the stock markets. Yet, less than 10% of public companies stopped reporting on a quarterly basis (as of the end of 2015).
Overall, reporting requirements continue to vary greatly across geographies (see detail below).
Looking back on historical changes to U.S. and U.K. reporting requirements provides tangible insights into how changes in reporting frequency have affected public companies in the past.
In the U.S., academic research has shown that public companies saw a decrease in their cost of equity capital when voluntarily or mandatorily increasing reporting frequency. In fact, companies that chose to report more frequently during the period 1951 to 1973 experienced a reduction in cost of capital by more than 60 basis points.
Proponents of quarterly reporting note, “Investors highly value more frequent reporting because it reduces the risk of buying stocks based on currently available information.” Additionally, Wharton professor David Zaring explains, “If you get regular information, then you might be more inclined to trust the company, which should lower the cost of capital.”
Changes in reporting frequency do not only influence the cost of capital, but also impact market liquidity. Bid-ask spreads represent a good proxy for information asymmetry, and the academic literature has shown that greater disclosure frequency is strongly correlated with lower bid-ask spreads.  The reduction in information asymmetry derived from quarterly reporting explains why investors who have less information with semi-annual reporting are more hesitant to trade.
Lastly, according to the CFA Institute, the change in reporting requirements in the U.K. has shown that extending the reporting period from three to six months negatively impacts the sell-side coverage of public companies and the accuracy of analyst forecasts.
The decision to provide guidance will heavily depend on a number of factors including, but not limited to the following:
The decision to provide quarterly or annual guidance (or both) will be driven by the same factors cited above as well as the following:
While CEOs’ willingness to move away from quarterly reporting is understandable given the associated costs and distraction, quarterly reports have many benefits for public companies and are not only about short-termism. They provide an opportunity for management teams to control the narrative, manage perception and engage with the investment community on a regular basis.
Quarterly earnings calls are also an opportunity to discuss the performance of the company in the broader context of industry trends. A certain level of transparency and disclosure is key to build investor confidence, as investors inherently rely on public information to make investment decisions, which, in turn, contribute to market efficiency.
This is particularly important for smaller companies, or companies undergoing change. More volatile performance, significant and/or rapid changes to the business and generally more complex business models require regular updates to drive better awareness, alignment and engagement with the investment community.
1. 2018 Responsible Investing Survey, RBC Global Asset Management, (October 2018).
2. Jamie Dimon and Warren E. Buffett, Short-Termism Is Harming the Economy Public companies should reduce or eliminate the practice of estimating quarterly earnings, The Wall Street Journal, (June 6, 2018).
4. Business Roundtable Supports Move Away from Short-Term Guidance, Business Roundtable, (June 7, 2018).
8. Short-Termism Survey Practices and Preferences of Investment Professionals, CFA Institute, (May 28, 2008).
9. Peggy Hsieh, Timothy Koller, S.R. Rajan, The misguided practice of earnings guidance, McKinsey&Company, (March 2006).
10. Shuping Chen, Dawn Matsumoto, Shiva Rajgopal, Is Silence Golden? An Empirical Analysis of Firms that Stop Giving Quarterly Earnings Guidance in the post Regulation-FD period, University of Washington, (October 2006).
12. Michael J. de la Merced and Matt Phillips, Trump Asks S.E.C. to Study Quarterly Earnings Requirements for Public Firms, New York Times, (August 17, 2018).
14. Neil King Jr., Hillary Clinton Is Not the Only Critic of ‘Quarterly Capitalism’, The Wall Street Journal, (July 31, 2015).
15. David Benoit, Time to End Quarterly Reports, Law Firm Says, The Wall Street Journal, (August 19, 2015).
17. Lawrence H. Summers, We have lots of problems in corporate governance. Systemic short-termism isn’t one of them, The Washington Post, (September 3, 2018).
18. Directive 2013/50/EU of The European Parliament and of The Council, Official Journal of the European Union, (October 22, 2013).
19. Robert C. Pozen, Suresh Nallareddy, and Shiva Rajgopal, Impact of Reporting Frequency on UK Public Companies, CFA Institute, (March 2017).
21. Fu, R., Kraft, A., and Zhang, H., 2012. Financial reporting frequency, information asymmetry,and the cost of equity. Journal of Accounting and Economics, 54(2), 132-149.
22. Robert C. Pozen and Mark Roe, Keep Quarterly Reporting, CFO.com, (August 27, 2018).
23. Joshua R. Mitts, Quarterly Reporting and Market Liquidity, (August 27, 2018).
24. David Zaring and Donald Langevoort, Should Companies Abandon Quarterly Earnings Reports?, Wharton University of Pennsylvania, (August 27, 2018).