Quarter end. These two words evoke many mixed emotions for CEOs, CFOs and other officers of a company the world over. Sometimes, cause for celebration of targets met or exceeded, and other times cause for concern that corporate or sales strategies aren’t working or haven’t been as effective as envisaged. Compound this if you are a publicly traded company with analyst forecasts and expectations from the street ready to buy or sell a stock based on these earnings forecasts and if they have been met, exceeded or missed. It doesn’t exactly evoke a long-term view of performance or reward a strategy that might take a bit longer to see results.

Much has been written about quarterly earnings forecasts – if companies provide them, if not, why not and if they do, if they have the credibility to meet them quarter after quarter. The question at the back of anyone’s mind has to be at what cost does meeting these forecasts impact long term financial and operational performance?

Most recently the Oracle of Omaha, Warren Buffet and Jamie Dimon, CEO of JP Morgan Chase have weighed in on the argument in the form of an editorial in the Wall Street Journal. Both are in favour of companies to stop providing earnings forecasts and take a longer-term view of reporting results and earnings.

“Quarterly earnings guidance often leads to an unhealthy focus on short-term profits at the expense of long-term strategy, growth and sustainability,” they said. In the latest appeal, they said companies often hesitate to spend on technology, hiring, and research and development to meet quarterly earnings forecasts that can be affected by seasonal factors beyond their control. At JP Morgan’s investor day in February 2018, Dimon called on companies to stop providing guidance, saying earnings are hard to predict and companies have an incentive to fudge numbers. Buffett has echoed the idea that guidance can lead to corporate misbehavior.

According to an FCLT Global Report, fewer than a third of S&P 500 companies still issued quarterly guidance in 2016, down from 36 percent in 2010. About 31 percent gave annual earnings-per-share guidance. Companies such as Unilever, Facebook, GlaxoSmithKline and BP have scrapped the practice in favor of multiyear outlooks, according to the report.

Even Donald Trump has weighed into the debate. In August of 2018 he asked the US Securities and Exchange Commission to consider reducing how often public companies must report earnings to investors from every three months to every six months, basically for the same reasons Buffet and Dimon state.

The argument has academic validity. According to an article published in 2006 in the Financial Analysts Journal authored by Harvey, Rajgopal and Graham, they uncovered some startling findings.

“CFOs believe that hitting earnings benchmarks is very important because such actions build credibility with the market and help to maintain or increase their firm’s stock price in the short-run,” they stated. But, the authors found that credibility came at a cost. “A surprising 78 percent of the surveyed executives would destroy economic value in exchange for smooth earnings,” they wrote. “CFOs argue that the system (that is, financial market pressures and overreactions) encourages decisions that at times destroy long-term value to meet earnings targets.” One must keep this in mind when considering the debate on frequency of earnings reporting of public companies. The first being Management and their duty to create long term value for shareholders and secondly, of company shareholders who need transparency on results as they rely on Management to act in their best interests.

If the SEC and US domiciled companies all moved in this direction and reduced the frequency of reporting mandated or quarterly forecasting in general, one might raise the question that it would give US based companies and the American economy as a whole a competitive advantage against other public markets that choose to retain the quarterly reporting requirements. If nothing else, it would give us an interesting benchmark to see how companies fare in the move away from short term views.

Sources:

Financial Post
Wall Street Journal
IR Magazine