23.05.2007

“Companies should voluntarily stop giving earnings guidance”

Since the practice of issuing earnings guidance in the United States began in the 1980s, after the SEC allowed companies to include forward-looking projections, more and more investors focus(ed) on these figures. This short termism pressure may make corporate executives manage for the short-term, sometimes to the detriment of the long-term health of a company. Matthew Orsagh, Corporate Governance expert of the CFA Institute Centre for Financial Market Integrity, and Iris Uhlmann, press relations manager of the German CFA Society, suggest that companies should voluntarily stop giving earnings guidance.

In what way do listed companies react to the short termism pressure they are increasingly facing? 

Orsagh: When we began researching this topic, we came across a Duke  University study that interviewed over 400 corporate executives. Eighty percent of those who responded to the survey stated that they would decrease discretionary spending on areas of long-term business investment such as research and development, advertising, and hiring to meet short-term earnings targets. More than fifty percent said they would delay new projects, even if it meant sacrifices in value creation.

What is you own experience with this topic?

Orsagh: We heard of similar stories from the companies we talked to – that they feel pressure to meet quarterly earnings guidance expectations of investors and analysts, and feel their share prices will be unduly punished if they do not meet these expectations.

What consequences do companies fear if their company is unable to perform as forecasted in their earnings report?

Orsagh: Companies fear a number of reactions if their quarterly earnings projections are missed. Most severely by investors selling the company’s shares that may drive down the stock price. Some analysts may also downgrade a company if they miss an earnings target. The problem derives from a company missing an “earnings target” that they helped set. Missing such an earnings target sends a message to investors and analysts that a company cannot hit its own targets.

The CFA Institute engages in putting an end to the so-called short termism, i.e. the focus of the capital markets on quarterly figures and the earnings guidance game. What is the alternative?

Orsagh: We suggest that companies and capital markets as a whole should voluntarily stop focusing on giving earnings guidance. Instead, they should pay more attention to their long-term goals and their strategic business model. Uhlmann: Quarterly reporting itself is important. What is unhealthy is quarterly guidance and the way companies attempt to meet their earnings expectations even if this can lead to negative consequences with regard to long-term value. If a company stopped giving quarterly guidance, but continued its quarterly reporting: Shareowners would receive the same amount of information.

What are the formal requirements for quarterly reports in your opinion?

Uhlmann: A balance sheet and statement of cash flows should be included. Tables and information should be placed consistently. The new report of the CFA Centre “Apple to Apples: A Template for Reporting Quarterly Earnings” explains this.

Some companies in the USA have already stopped giving earnings guidance. What are the results to date?

Orsagh: Studies on companies who have stopped giving guidance show that initially, in the short term (a few days following an announcement that a company is no longer giving quarterly guidance), investors react negatively – and stock prices decline and volatility increases. Over the long term, however, companies that stop giving quarterly earnings guidance do not see any decrease in stock price.