As a stock analyst coming up through the investment ranks, I always wanted more information, never less. There was no risk of too much information. Quarterly reporting of cashflow statements and regular publication of detailed operational data seemed the bare minimum. The flood of numbers allowed me to build out elaborate company models that were the basis of my recommendations to the portfolio managers. My initial mandate included European securities, and I was dismayed that the they could and often did report less frequently and less fully. The nerve!
Now as a portfolio manager, particularly one with a strong bias toward long-term business ownership (rather than short-term stock flipping), I wish that most of the companies that we own had the option of reporting less rather than more. The consequences of detailed quarterly reporting are well known in the investment and business community: public-company managers make bad or short-term decisions, or bad and short-term decisions just to make their quarterly reporting look better. In Getting Back to Business, I noted a few of the methods companies have at their disposal to goose their reported profits in any given quarter. (I also noted that required quarterly reporting is a relatively recent phenomenon—dating from the 1960s, with the cashflow statement becoming obligatory only in the 1980s. Quarterly reporting came as part of the answer to an utter paucity of information public companies had provided up through the Great Depression. The question is how much is too much.)
The financial media is filled with examples of executives of public companies acknowledging the pressure of near-termism associated with quarterly reporting, the conference calls, and the particularly parlous “earnings guidance” that much of the public company community provides. And one regularly hears of executives of companies going private—and therefore no longer needing to play this game—and how happy they are to be free of doing so. Long-term business projects can take, well, a long time. And they invariably consume cash during in the early years. That is the price of innovation and advancement. Many projects inevitably fail. But having investment projects artificially changed or ended prematurely due to the necessity of “making the numbers” this quarter for stock speculators is simply bad for business.
It’s not surprising, therefore, that the calls to lighten up on reporting have grown louder in recent years. The issue came to the fore in August due to a Presidential tweet directing the SEC to look into the issue. That has lead to numerous commentaries in the financial media either for or against quarterly reporting. The majority of pundits seem to be on the side of continuing the current practice. Larry Summers opinion piece in the Financial Times, “Ending quarterly reports will not prevent short-termism,” (September 4, 2018, US edition) is a typical example. The former Treasury Secretary and current Harvard University Professor makes the reasonable and expected rebuttals to the proposal: Amazon and its ilk, and a large number of publicly traded biotechs—have done very well indeed in making long-term, paradigm-changing investments, despite having to bare their cashflow-free business models every quarter. And he makes the interesting observation that many private equity and venture capital-funded companies report the state of their affairs on a monthly basis (to the company owners), to no apparent ill effect. Finally, he points out less frequent reporting could lead to more volatile markets due to an increase in the number of “surprises.” Quarterly reporting also has the virtue of helping to expose malfeasance by corporate managers. Think Enron or the example in Summer’s piece: GE in the past few years. In this line of thinking, sunlight is a strong disinfectant and frequent exposure is a good way to keep the corporate body as germ-free as possible.
Those are all valid points, as far as they go, but they do not go far enough. First, we really can’t tell whether in a statistical sense whether detailed quarterly reporting leads to better or worse decisionmaking (or accountability, as it more likely to be phrased.) You can’t do a controlled experiment. And the efforts to compare outcomes across time periods or in different geographies with varying reporting standards are simply not convincing. Instead, we are left with the intuitive judgment—which academic finance abhors—where short term detailed public reporting for assets which reprice daily is clearly not a way to encourage better, longer-term decision making. This assertion can’t be proven in a scientific sense, but it can’t be disproven either.
But quarterly reporting affects far more than the outcome of long-term investment projects by public corporations. Publicly traded assets reprice everyday. That daily liquidity is a wonderful thing, but it also creates a parallel universe of risk and opportunities. The sad fact is that senior executives, who are often paid in shares, can become excessively, myopically focused on their share price today, tomorrow and the day after, rather than the long-term trajectory of the business. Frequent, detailed reporting creates a behavioral risk for managers seeking to maximize their own stock-related wealth. Less frequent or less detailed reporting may not get rid of senior executives staring at their Bloomberg screens all day or worrying about how to get their share prices up, but it does reduce one of the sources of temptation.
More importantly from my perspective, the impact of quarterly reporting on corporate managers, their business decisions, and their personal wealth constitutes only “half” the issue. Few of the commentators address the issue from the perspective of the investor. And that is the second, underappreciated weakness of the current practice. “The fault, dear Brutus, is not in our [shares], but in ourselves.” We the investors are also at risk of making bad marginal decisions when flooded with too much near-term noise. Are sales slightly more or less than expected this month rather than last month? Is the rate of change of the rate of change shifting during the past three months and should we trade on that information? The obsession with the here and now can have the same impact on investors as it does on corporate managers—do what looks good for the portfolio right now rather than for risk-adjusted long-term returns. Professional investors are supposed to be able to look through that near-term noise but the pressure on investment managers to perform, and perform now, is eerily similar to the pressure on the corporate managers themselves. There are many causes for this near-termism (discussed at greater length in Getting Back to Business); quarterly reporting may be only one of them and, frankly, it is far from the most important. But any way to discourage near-term performance chasing by investors should be encouraged.
These are some of the pros and cons of quarterly reporting. I lean in the direction of modestly “less” reporting potentially being “more” (in the sense of better) for many companies and their owners. But if I sound somewhat blase about this debate, it is because it may not really matter. The reason we have to argue whether quarterly reporting is good or bad for corporate decision making is because we’re not making the decisions. The people we hire are. Or to be more precise, the executives hired by the Board of Directors, whom we vote for. (How much we as individual or institutional investors actually control who gets into the C-Suite and how accountable they are to shareholders is a separate, century-long debate. See Berle & Means [1932], and Jack Bogle’s perspective in the most recent issue of the Financial Analyst Journal, 2018).
The issue of quarterly reporting is is just one facet of this natural and perhaps unresolvable tug of war between the “hired help” (the Board of Directors and senior managers) and the individuals and institutions who actually own the company. The latter may believe that more frequent detailed reporting from public companies leads to greater accountability of their agents, but that greater accountability comes at the risk of incremental near-termist, bad decision-making by those same agents (as well as investors themselves).
In creating and financing the modern corporation over the past century and a half, we generated a lot of agency costs. In return for scale and limited liability, we lost direct control of our capital. In that light, the quarterly reporting question becomes a quite different and more human behavioral challenge: do you trust the managers hired to run your business (and the board elected to oversee them)? If you generally do, semi-annual or even annual reporting would do. If you don’t, detailed quarterly reporting should be de rigueur and might even need to be supplemented my monthly reporting, as is apparently the practice in the world of private equity.
So the current debate about quarterly reporting and corporate decision making is really about whether managers are more or less trustworthy than they were a century ago, a few decades ago, a few years ago? Should the leash be tighter or looser? Investors will disagree on that question, but for the type of large, stable companies that I prefer, a bit looser would be fine. Investors who concentrate in smaller, new companies may disagree, but they face the incremental factor of the paperwork burden and time sink that detailed quarterly reporting represents. Since it is impractical (but not impossible) to have different reporting standards for companies of different sizes and tenures, a modified quarterly reporting may a good compromise. That might look like full semi-annual reporting, with just sales or unit reporting at the end of the first and third quarters. (This is similar to the reporting one sometimes encounters from certain European companies.) There is nothing magical about that solution; it is just a compromise to make a difficult, multi-faceted challenge a bit easier. No longer providing quarterly or even annual earnings guidance would be equally helpful and, because it is not legally required, easier to achieve.
Note: The views expressed here are those of the author alone, and do not necessarily reflect the views of his employer. Nothing written here should be construed as investment advice. Consult your investment advisor for specific recommendations.