Just Say No to Wall Street: Putting a Stop to the Earnings Game

Michael Jensen is the Jessie Isidor Straus Professor of Business Administration, Emeritus, at Harvard Business School.

In a Journal of Applied Corporate Finance paper, Just Say No to Wall Street: Putting a Stop to the Earnings Game, my co-author, Joseph Fuller of The Monitor Group, and I discuss the notion of putting an end to the “earnings game.” This requires that CEOs reclaim the initiative by avoiding earnings guidance and managing expectations in such a way that their stocks trade reasonably close to their intrinsic value. In place of earnings forecasts, management should provide information about the company’s strategic goals and main value drivers. They should also discuss the risks associated with the strategies, and management’s plans to deal with them.

Using the experiences of several companies, we illustrate the dangers of conforming to market pressures for unrealistic growth targets. We argue that an overvalued stock, by encouraging overpriced acquisitions and other risky, value-destroying bets can be as damaging to the long-run health of a company as an undervalued stock.

CEOs and CFOs put themselves in a bind by providing earnings guidance and then making decisions designed to meet Wall Street’s expectations for quarterly earnings. When earnings appear to be coming in short of projections, top managers often react by suggesting or demanding that middle and lower level managers redo their forecasts, plans, and budgets. In some cases, top executives simply acquiesce to increasingly unrealistic analyst forecasts and adopt them as the basis for setting organizational goals and developing internal budgets. However, in cases where external expectations are impossible to meet, either approach sets up the firm and its managers for failure and in the process value is destroyed.

The full paper is available for download here.

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