Risk & Compliance

Trade Groups: Dump Quarterly Guidance

The obsession with short-term results hurts shareholders and impedes efforts to strengthen corporate governance, says a new report.
Stephen TaubJuly 25, 2006

Two trade group have called on companies and other stakeholders to end the practice of providing quarterly earnings guidance.

The CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics issued a report calling on corporate leaders, asset managers, investors, and others to break the “short-term obsession harming shareholders” interests by reforming practices involving earnings guidance, as well as compensation, and communications to investors.

“The obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the un-intended consequences of destroying long-term value, which decreases market efficiency, reduces investment returns, and impedes efforts to strengthen corporate governance,” the report said.

In addition to ending quarterly earnings guidance, the trade groups called for:
• Aligning corporate executive compensation with long-term goals and strategies and with long-term shareowner interests.
• Improving disclosure of asset managers’ incentive metrics, fee structures, and personal ownership of funds they manage.
• Endorsing the use of corporate long-term investment statements to shareowners that will clearly explain “beyond the requirements that are now an accepted practice” of the company’s operating model.

The report urged corporate leaders to communicate long-term strategic objectives and related performance benchmarks, rather than provide quarterly earnings guidance. Further, it supported analysts and asset managers who use a long-term focus in their analyses and capital investment decisions.

At the same time, the panel that wrote the report asserted that companies with strategic needs for providing earnings guidance should adopt guidance practices that incorporate a consistent format, range estimates, and appropriate metrics that reflect overall long-term goals and strategy. To that end, panel members pledged to support corporate transitions to higher-quality, long-term, fundamental guidance practices, which will allow highly skilled analysts to differentiate themselves and the value they provide for their clients.

Securities and Exchange Commission Chairman Christopher Cox also weighed in on the CFA/Business Roundtable proposal during his testimony before the Senate Banking Committee hearing on hedge fund regulation on Tuesday. Cox noted that that frequent guidance was a contributor to “manipulating, managing, smoothing earnings,” and that if it amounted to nothing more than to contribute to the general ethos, then ending earnings guidance would be a “good thing.”

The CFA/Business Roundtable report encouraged companies to provide more meaningful, and potentially more frequent, communications about strategy and long-term vision, including more transparent financial reporting that reflects a company’s operations. Meanwhile, the report recommended that companies move away from complicated accounting and legal language in financial reporting, and increase their use of “plain language.”

The plain language issue is a double-edge sword, however. In a separate study issued earlier this month, a law firm concluded that the SEC favors easy-to-understand footnotes and other descriptive financial reporting prose, but it does not like it when companies try to simplify SEC definitions. The study, conducted by Steve Quinlivan and Jill Radloff of Minneapolis law firm Leonard, Street and Deinard, reviewed letters written to companies by the SEC staff, who categorically protested the rewording of SEC definitions.

The concept of eliminating earnings guidance has been broached before by corporate and investor groups. In fact, in recent months, several companies have announced plans to dispense with issuing quarterly guidance.

For example, earlier in July, RadioShack became the most recent company to announce it was changing its earnings guidance policy, noting that it would not host conference calls when it issues its quarterly earnings updates. “RadioShack management is wholly focused on improving operations and building value for shareholders and believes this approach best serves both goals,” said chairman and chief executive officer Julian Day, who joined the firm earlier this year after spending time at Sears, which also recently instituted a similar policy.

Officials of the CFA and Business Roundtable said that the report’s findings and recommendations are based upon joint research and several symposia discussions with key stakeholders, including: corporate issuers, analysts, asset managers, shareowners, institutional investors, hedge fund managers, regulators, and the media.