Quarterly Guidance: A Relic of the Past?

July 2, 2018 0 Comments

Most publicly traded companies view quarterly guidance as necessary. We’ve always been in the habit of reporting quarterly earnings, therefore, it has turned into somewhat of a ritual. The pros and cons of quarterly earnings are discussed regularly in the investment community. The effects, however, are highly disputed. On one hand, companies use quarterly earnings guidance announcements to explain trends that might affect their financial performance. On the other, corporate management are compelled to adopt short-term strategies in an attempt to make their own quarterly performances seem impressive. As more firms choose to either provide — or not provide — quarterly earnings, it seems the this is one of the few debates in modern finance that remains unsolved. Until now, perhaps?

Recently, J.P. Morgan Chase & Co.’s CEO Jamie Dimon and Berkshire Hathaway Inc. CEO Warren Buffett decided to join forces urge CEOs to end quarterly earnings forecast in a joint Wall Street Journal editorial. The two men are considered titans among the financial industry; they have stated that the practice of telling Wall Street what to expect from earnings can distort management priorities, which is a reasonable argument. Their latest op-ed suggests that companies often hesitate to spend on technology, hiring, research and development (R&D) to meet quarterly earnings forecast that can be affected by seasonal factors beyond their control.

The argument that “quarterly capitalism” is bad for the economy, and therefore, harmful for corporations in the long-run is one of those ideas that is intuitively appealing. However, the data supporting it seems pretty thin. Unfortunately, Dimon and Buffet fail to offer any fresh evidence in their new op-ed.

The following quote is the only substantive assertion that they make in the piece, and they don’t support it with anything:

The pressure to meet short-term earnings estimates has contributed to the decline in the number of public companies in America over the past two decades. Short-term-oriented capital markets have discouraged companies with a longer term view from going public at all, depriving the economy of innovation and opportunity. Fewer public companies has also meant fewer opportunities for retail investors to create wealth through their 401ks and individual retirement accounts.

If this is the case, do private companies invest more or less than public companies for the long-term? Do companies that don’t offer guidance investment more or less than firms that still offer guidance? Are there non-US markets where the culture of guidance is different than in the US? If so, what do the results show?

The issue of quarterly earnings isn’t considered a serious contention of debate, and the results appear to be mixed. However, a recent report from FCLT Global has found that fewer than a third of S&P 500 companies still issued quarterly guidance in 2016, down from 36 percent in 2010. Public companies such as Facebook, Unilever, Coca-Cola, Marriott, GlaxoSmithKline, and BP have decided to abandon the practice in favor of multiyear outlooks.

There are many compelling reasons why managers would be eager to scrap earnings guidance; there are many interesting arguments in favor of the practice. However, I believe people tend to focus on the benefits of abandoning this practice, instead of examining the reasons why firms do. After all, most firms do not announce or explain changes in their guidance policy. Among those that do, frequent reasons for stopping are the redirection of investors’ attention from quarterly earnings to the long-term goals of the company, managers’ difficulty in predicting earnings, and following industry guidance practices.

 

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