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E-MailRobert C. Pozen is a senior lecturer at MIT’s Sloan School of Management. Mark Roe is a professor at Harvard Law School. Related research from the Program on Corporate Governance includes Corporate Short-termism—In the Boardroom and in the Courtroom by Mark Roe (discussed on the Forum here); and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).
The clamor against so-called corporate short-term thinking has been steadily rising, with a recent focus on eliminating the quarterly earnings report that public firms issue. Quarterly reports are said to push management to forgo attractive long-term projects to meet the expectations of investors and traders who want smooth, rising earnings from quarter to quarter.
The U.K. recently eliminated mandatory quarterly reports with the goal of lengthening the time horizon for corporate business decision-making. And now Martin Lipton, a prominent U.S. corporate lawyer, has proposed that U.S. companies’ boards be allowed to choose semiannual instead of quarterly reporting. The proposal resonates in Washington circles: Presidential candidate Hillary Clinton has criticized “quarterly capitalism” as has the recently departed Republican SEC Commissioner Daniel Gallagher.
But while quarterly reporting has drawbacks, the costs of going to semiannual reporting clearly outweigh any claimed benefits.
On the claimed-benefit side, it is doubtful that replacing quarterly with semiannual reporting will induce corporate executives to make longer-term business decisions. Do we really believe that moving from quarterly to semiannual reporting will bring forth many new five-year investment projects? Similarly, without quarterly reporting, why won’t earnings smoothing occur in six-month intervals instead?
Another drawback: With semiannual reporting, actual earnings will more frequently drift further away from management’s projections, giving companies more reason to smooth earnings semi-annually. Worse, with companies going dark for six months, the gap between inside information and public information will widen—increasing the temptation for insider trading.
Quarterly earnings reports are highly valued by stockholders and analysts because they want up-to-date information on the company. Even John Kay—the distinguished academic and journalist who promoted Britain’s elimination of mandatory quarterly reporting—recognized that most U.S. investors dislike the U.K.’s move from quarterly to semiannual reporting because, as he told Reuters, they believe it could make company information less transparent.
While financial reporting is first for investors, letting each company’s shareholders decide when to report its earnings would undermine the efficiency of American capital markets. If American Airlines reports semiannually, but Delta doesn’t, stock analysts can’t readily compare firms within the airline industry.
Nevertheless, quarterly reporting can be significantly improved. Today almost all public companies issue a short press release summarizing their quarterly revenues and earnings. Management carefully drafts the summary, which independent directors on the company’s audit committee closely review. When the earnings release is issued, approximately three weeks after the quarter’s end, management typically hosts a long conference call for investors and analysts.
Market participants consider the earlier earnings release highly significant. By contrast, the company’s quarterly 10-Q report filed with the SEC—typically, a week to 10 days after the earnings release—is often considered a nonevent. The 10-Q is a phone-book-size document filled with legal jargon and accounting boilerplate. Most investors do not know what few sentences in it are new and not a repeat of the past quarter’s filing. Yet considerable management time is consumed in preparing this lengthy form.
We suggest a new sequence: Companies file their detailed annual report with the SEC (the 10-K) as they do now, and a detailed semiannual report. In between, public companies would issue two news releases explaining material changes in their revenues and earnings, paired with two streamlined quarterly reports filed with the SEC for public availability.
These reports would highlight any other significant developments—such as major new litigation or sizable acquisitions—that have occurred since the last annual or semiannual filing. The streamlined quarterly filings would include the company’s full financial statements, which mainly industry experts will read and thereby ensure the validity of the numbers in the earnings release.
Eliminating quarterly reporting would deprive investors and analysts of much-needed information in a fast-moving economy, and it would do little to push companies into better long-term investments. Streamlined quarterly filings, dovetailed with today’s typical earnings release, would be less expensive and time consuming. It would also provide investors with more focused disclosure of important company information and make for better-functioning stock markets.
2 Comments
I love this suggestion. I agree that you can’t give the market less information than they currently get. Eliminating quarterly SEC reporting can free up company resources that can be used to prepare more investor friendly reports in between semi-annual SEC reporting periods. I hope this catches on.
Why not simply let the market decide? The authors make the inconsistent claims that elimination of quarterly reporting would deprive the market of “much-needed information” and that Form 10-Qs are regarded as “non-events”. They also claim that semi-annual reporting will create temptations for smoothing of earnings and insider trading. However, they don’t explain why quarterly reporting is optimal. Why not every four months, monthly or even daily. They also fail to acknowledge that the SEC has vastly increased the amount of information that must be disclosed within four business days on a Form 8-K. Finally, if the authors are correct, the market will reach the same result.