Guiding Our Way to Quarterly Behavior?
Promoting Long-Term Thinking and Greater Transparency
Posted by Sarah Williamson, FCLTGlobal, on
Monday, October 8, 2018
By now, most business-watchers have seen the
tweet asking the Securities and Exchange Commission (SEC) to study the
requirement that US public companies release earnings quarterly. With this
message, President Trump has focused attention on the short-term mentality that
too often characterizes American business.
which followed his discussion with Pepsi CEO Indra Nooyi about how to
better orient corporations towards a more long-term view, has provoked
a flurry of discussion on how corporations can take a longer-term
approach to business and investment decisions, and in doing so, fuel
growth and innovation in their communities.
And rightly so. An
of publicly-listed US companies by the McKinsey Global Institute showed that
companies operating with a long-term approach consistently outperform their
peers on a wide range of metrics, including revenue growth, profitability,
shareholder return and job creation.
C-suite survey FCLTGlobal released with McKinsey and Company in 2016 is
telling: 55% of CFOs admitted that they would delay NPV-positive projects in
order to hit quarterly earnings targets. Clearly, too many capital allocation
decisions are made without a full appreciation of the long-term
implications—notwithstanding a few oft-cited exceptions such as Amazon. Most
Americans invest their retirement savings in these companies, and they depend
upon their success over several decades to enable them to retire with sufficient
savings or pay for their children’s education.
While the detrimental
effect of short-term behavior is real, shifting to semi-annual reporting in the
US raises legitimate fears of a lack of transparency with companies only
disclosing significant developments in their business twice a year.
There are four
solutions that the SEC could explore to encourage long-term behavior while
maintaining the disclosure that is critical to well-functioning markets:
Make it very clear that quarterly guidance is
neither required nor desirable
Encourage companies to report progress towards
their annual results rather than quarterly results per se
Encourage companies to provide long-term strategic
roadmaps, recognizing that the future may not unfold as expected
Study pairing any relaxation of the quarterly
reporting requirement with a strengthening of other disclosure rules to ensure
transparency in markets.
Quarterly guidance is neither required nor desired
It is critical to
distinguish quarterly guidance—forecasts issued by companies of future
earnings metrics—from quarterly reporting, the retrospective look at
how a company performed over the prior three months.
There is a common
belief that quarterly guidance is advantageous to companies and investors—and it
may have been in the pre-internet world of limited data and primarily retail
shareholders—but today it is a relic. Many market participants even believe that
quarterly guidance is required, which it is not, confusing the SEC’s
encouragement of forward-looking information as promoting short term guidance.
The SEC could more clearly underscore the distinction between quarterly guidance
and quarterly reporting.
Guidance is already
falling out of favor with American companies and is virtually non-existent in
Europe. In 2016, for example, only 27% of the S&P 500 and 0.7% of Euro Stoxx 300
offered quarterly EPS guidance (see figure 1).
Figure 1: Source:
Moving Beyond Quarterly Guidance: A Relic of the Past. FCLTGlobal, 2017.
Furthermore, there is
overwhelming evidence that investors (as opposed to the media or other analysts)
don’t like quarterly guidance either. According to a Rivel study, only seven
percent investors are interested in guidance metrics for periods of less than a
year. Similarly, an Edelman survey of institutional investors revealed that 68%
agreed that providing long-term guidance positively impacts their trust in
companies they are invested in or considering investing in.
FCLTGlobal, has also been vocal in its opposition to this practice. In
addition to underscoring investors’ desire to move away from the practice, our
research demonstrates that quarterly guidance has no impact on a company’s
valuation and in fact increases, rather than decreases, share price volatility,
particularly around reporting season.
Subsequent analysis from Bloomberg reinforces this: their analysis shows
that for 7 out of 9 quarters between 2016 and 2018, companies who issued
quarterly guidance (the guiders) experienced higher earnings surprise than
non-guiders, while the differences between the two for the remaining quarters
has been reinforced several times since our 2017 research was released,
including in a
powerfully-worded op-ed by Warren Buffet and Jamie Dimon, as well as by the
National Investor Relations Institute and the National Association of Corporate
Directors, both of which publicly support companies’ efforts to focus on the
long-term growth of their business and the economy as a whole.
An SEC statement
clarifying that quarterly guidance is neither required nor desirable could serve
as the nudge American companies need to begin aligning their focus with
long-term objectives. While it is unlikely that the SEC would ban the practice
of quarterly guidance given its historical approach of enabling voluntary
disclosure, it could nevertheless call attention to the problem, including by
asking companies who do issue quarterly guidance to disclose the extent to which
such practice creates a risk factor, whether the board and audit committee have
discussed with management the pros and cons of providing such quarterly guidance
and why the company believes providing quarterly guidance, as opposed to
longer-term frameworks for value creation, is in the best interests of the
company and its shareholders.
towards annual results rather than quarterly results
Another step the SEC
could take is to encourage companies to report their financial progress towards
annual results rather than quarter-by-quarter. Companies would report first
quarter results, then half-year results, then nine months results and then
finally results for the year without analyzing each quarter individually.
While anyone can do the
math and compare quarter over quarter, we have learned from the behavioral
economists how important framing is. Framing quarterly work as progress towards
a longer-term goal is costless and could serve as another nudge for long-term
thinking. When discussing quarterly results, companies would situate them within
the broader context of the company’s strategy, longer-term objectives and a
year’s worth of progress.
Providing long-term strategic roadmaps
We and others have been
encouraging companies to develop clear long-term strategic roadmaps in place of
quarterly guidance. Such strategic roadmaps can focus shareholders on a
company’s longer-term plans and provide them with the opportunity to evaluate
both the strategy and the management team’s execution of that strategy.
Companies also have more flexibility in deciding the right metrics to use when
conveying long-term strategic roadmaps. In a recent Financial Times column,
Harvard Professor Larry Summers bolsters the case for providing long-term
guidance by stating, “Wise corporate leaders should give a sense of their
long-term vision on at least an annual basis. Investors who insist on such
information are only being reasonable.”
The most common concern
we hear about providing such strategic roadmaps is a legal one: that companies
will be open to criticism if those plans do not come to fruition or if they need
to pivot as market conditions change.
To assuage this
concern, the SEC could provide clear direction to companies and investors alike
about the parameters for providing long-term strategic roadmaps and any
resulting liability, confirming that safe harbors for forward-looking statements
and other protective measures will apply to such long-term outlooks. Having
long-term oriented dialogues between companies and their shareholders supports
the allocation of resources to productive long-term uses.
Strengthening intra-period disclosures
There are many examples
of countries that do not require quarterly reporting. These countries have often
paired less regular financial statement reporting with stringent continuous
reporting of significant changes to a company’s business. This continuous
reporting framework offsets the concern that less frequent financial reporting
will lead to either very significant, discontinuous disclosures every six months
or the opportunity for insider trading.
It would certainly be
appropriate for the SEC to study the issue of quarterly reporting as the
president suggested. It can do so by examining the requirements in other
countries, such as the UK and Australia, for continuous disclosure, and looking
into whether today’s Form 8-K framework in the US for “current” reporting of
specified material events should be broadened to enable less frequent reporting
of full financial statements. Reporting is essential to maintaining transparency
for all shareholders, and mechanisms such as making on-going disclosure
requirements more robust could be appropriate.
The UK’s recent
experience in changing reporting frequency is also worth noting. It now requires
only half-yearly reporting, reversing a 2007 decision to implement quarterly
reporting. Both domestic and foreign investors encouraged the shift, and there
are a number of major institutional investors who continue to encourage the UK
companies that report quarterly to stop the practice.
Research from the CFA Institute indicated that for the periods studied and
using their methodology, the frequency of financial reporting had no material
impact on the levels of corporate investment, so relaxing quarterly reporting
requirements is not a panacea for short-term thinking. However, their research
also showed no impairment of analysts’ ability to forecast corporate
performance, assuaging some concerns about the impact of reductions in the
frequency of reporting.
We commend any attempt
by the White House, the SEC, and American business to combat short-term
pressures in our capital markets. While considering various reporting standards
is certainly a legitimate exercise, the evidence for addressing quarterly
guidance is much stronger than for addressing quarterly reporting and merits
By encouraging the
elimination of quarterly guidance, the reporting of progress towards annual
results, and the issuing of long-term strategic roadmaps, the SEC could have a
very significant impact on short-termism even within the current regulatory
Harvard Law School Forum
on Corporate Governance and Financial Regulation
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