Why a Twice-Yearly Earnings Schedule Is No Fix for Short-Termism
SMITH BRAIN TRUST – Should publicly traded companies stop reporting earnings every quarter, opting instead for a twice-a-year schedule?
Proponents of the change say it would relieve the pressures CEOs feel to outperform analyst forecasts every three months. Those pressures has long been blamed for discouraging companies from taking the long view in strategies, investing in research, hiring, equipment, technology and other fundamental aspects of business.
Maryland Smith’s Rachelle Sampson has studied the effects of short-termism. Her research has shown that a short-term focus has become significantly more prevalent in the past three decades among firms and their investors.
Nonetheless, as she listens to the current arguments in favor of abandoning the quarterly earnings schedule, she says much of the debate essentially misses the point. She says those reporting requirements aren’t very onerous, as some people contend.
The practice of delivering quarterly earnings-per-share guidance already is largely on its way out, says Sampson, associate professor of logistics, business and public policy at the University of Maryland's Robert H. Smith School of Business. And, she says, it’s small potatoes compared to what’s really driving short-termism: CEO compensation and its link to share prices.
“The discussion about ‘onerous’ reporting requirements for publicly listed firms comes up frequently,” Sampson says. But they aren’t particularly onerous, she says. In fact, she would lobby for more disclosures from publicly traded firms. “By and large transparency is essential for well-functioning markets.”
The issue, she says, is that firms often focus on managing market expectations at the expense of what she calls “real performance.”
Firms that issue earnings guidance are essentially setting expectations to drive stock prices, and delivering an imperative for senior management to meet those expectations. The practice has been falling out of favor.
The quarterly vista is myopic. So many factors can impact a company’s quarter – from geopolitical uncertainty, to trade talks, to weather events.
JPMorgan Chase’s Jamie Dimon and Berkshire Hathaway’s Warren Buffett have both urged companies to move away from providing quarterly earnings-per-share guidance, writing in The Wall Street Journal that the practice “often leads to an unhealthy focus on short-term profits at the expense of long-term strategy, growth and sustainability.”
The most significant factor contributing to short-termism, Sampson says, is the fact that CEO compensation is usually tied to stock price, whether through explicit stock price targets that trigger bonuses, or stock grants and options included as part of compensation packages.
“The whole argument that switching to six-month reporting instead of quarterly reporting is going to reduce short-termism because analysts will only be making projections every six months kind of misses the point,” she says. “Analyst expectations only affect firm behavior when CEOs are more motivated by stock prices, rather than fundamentals.”
Those fundamentals are what Sampson calls “real performance.”
Reporting on a six-month schedule wouldn’t solve that problem. It would result only in firms releasing less information on the actual company performance. “And in that case, one might expect that stock prices might be even less tied to fundamentals than they were previously,” she says.
There are, she says, better solutions.
“CEO compensation would be a good place to start,” she says. “There is too much CEO compensation that is tied to stock performance, which leads CEOs to want to manage expectations for performance.”
She suggests that companies disentangle CEO compensation from stock price and instead tie compensation to a metric that’s more closely aligned with performance, such as profits over the medium to long-term. The move, she says, would encourage many firms to take a longer-term horizon.
“The analysts shouldn’t be the taskmasters for companies,” she says. “The CEOs should be slaves to firm performance and how the firm is doing over a longer time horizon. And not worrying about analyst expectations.”
“We have seen the deleterious effects of tying CEO compensation to stock price, particularly in the short run, causing harm throughout the economy. So it really is time to try something else, something more related to actual, rather than expected, firm performance.”
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