This post is not about a recent development or practice tip. It is a “trial balloon” to test, in a public forum, my outlier but serious proposal that has haunted me for almost 20 years. I began a fairly long article about it in 2005, but colleagues and other friends talked me out of it then. I have now escaped their clutches and plan to complete the article, perhaps depending on the reactions to this post. I have already been called a latter‑day Don Quixote, and told that the article is a fool’s errand, by friends. So, don’t be shy or pull any punches.
The Proposal, In Summary
I propose that a company’s fiscal year, rather than quarterly periods, be the periodic reporting cycle for financial and other operating results performance information. As a result, under my proposal, the quarterly report on Form 10-Q would be eliminated. The annual report on Form 10-K and current report on Form 8‑K would both remain, in essentially their respective present forms. The parallel derivative rituals of quarterly earnings releases and quarterly conference calls would also be eliminated, along with any other listing criterion based on quarterly reporting that is imposed by the New York Stock Exchange, the Nasdaq Stock Market or any other trading market that is subject to SEC regulation.
As an integral component of my proposal, all public companies would be required to give guidance about anticipated earnings for the upcoming fiscal year (although not for any interim period thereof) as part of each year’s annual report on Form 10-K. The company would also be required to assess developments over the course of the fiscal year to determine whether operations are on track with the guidance. If some development indicates that a material deviation from the guidance is likely, whether favorable or unfavorable, the company would be required to promptly disclose relevant information about that development and to adjust the prior guidance accordingly.
My proposal would not change any current rule that requires insiders to disclose promptly their trading activities with respect to their companies’ securities.
Principal Reasons and Rationale
There is inherent tension between the short-term nature of our quarterly periodic disclosure regimes, on the one hand, and the stated desire for (and putative imperative of) long-range strategic planning by companies and managements in order to enhance long-term shareholder value, on the other hand. That tension inevitably translates, in practice, into an actual conflict between two competing interests, each of which can be legitimate on its own terms: (a) building and enhancing shareholder value as measured by the intrinsic and long-term strength (or worth) of a company, and (b) lawfully promoting the day-to-day trading prices of the company’s equity security. Such tension is at the root of most problems that lead to both corporate scandals involving misstated earnings (or other operating results) and short-sighted, speculation-driven trading behavior.
Our quarterly periodic disclosure regimes accentuate the disconnection between those two interests and lead corporate actors and investors to focus inordinately on short-term results to the detriment of sound strategic planning for long-term value creation. They ensure that the behavior of managements of public companies will be influenced significantly (if not driven) by achieving performance results on a quarterly basis. The resulting short-term focus and its myriad manifestations – which are captured by the phrase “short-termism” – are a pervasive problem and a malady.
That condition, however, is neither inevitable nor a prerequisite for an efficient or effective capital markets system. It is principally a consequence of our current disclosure regimes having made the three-month quarterly cycle of reports and rituals a major touchstone for tracking and measuring performance by public companies. It can be cured with real medicine.
I believe we have been led to stay this course, ignoring the real cure, by the tempting illusions of the “efficient capital markets theory”, which fosters an ethos of near‑immediate disclosure of virtually all material information about the performance of public companies. The illusions condition us to believe that market participants who are armed with such information will use it rationally in making investment decisions; that such investments reflect and yield logical allocations of capital; that such allocations, in turn, will yield a rational and value-based pricing of the securities; and that good things otherwise have followed (and will continue to follow) for the U.S. capital markets system and the American economy.
As an aspirational model or reference points for developing the substance of public disclosures, that’s all fine. As the fundamental justification or premise for the frequency of such disclosures imposed by our quarterly regimes, however, those beliefs are seriously flawed.
If we want to promote a longer-term and more strategic focus by public companies and their management; if we want analysts, investors and other market participants to focus on long-term value propositions; if we want to curtail short-termism more generally; and if we want to shape and encourage such behaviors, then we must rethink the fundamentally short-term timetable we have established for our periodic disclosure regimes, and administer some real medicine. We cannot expect such long-term focus and behavior, while requiring short-term measures.
Why the Guidance Requirement?
The annual earnings guidance component of my proposal may appear to be gratuitous, because such a requirement arguably is not compelled in order to address the short-termism problem and malady. While my proposal could be implemented without the guidance requirement, I believe it is important. Investors and other capital markets participants will inevitably require certain forward-looking information in order to make strategic and rational investment decisions. The current informal, non-required, practice of providing earnings guidance arose to address that practical reality. There is no reason to believe that that reality would change under my proposed annual disclosure regime. Accordingly, I believe it is better to embrace that reality and develop a system that can help guard against the emergence of behavior that undermines the benefits of changing to an annual periodic reporting regime. I believe instituting a formal, annual earnings guidance requirement would help prevent the reemergence of an informal but wide-spread guidance practice that continues the current quarterly focus.
My proposed guidance requirement is not a long step from either the SEC’s implicit position or prevailing practice. While the SEC does not encourage earnings guidance, it readily accepts the current informal practice, and it otherwise encourages disclosures that look into the future based on “trends” and certain other matters that companies know. Many (if not most) public companies already provide earnings guidance voluntarily. With respect to major public companies that do not presently provide earnings guidance, I suspect their position is based primarily upon an aversion to the quarterly focus for which guidance is expected if it is given, and the resulting problems of short-termism that flow from a quarterly focus.
My proposed guidance requirement is logical, reasonable and fair, especially as a trade-off for eliminating the unhealthy consequences of quarterly operating disclosures. It is not unreasonable to require a public company to give its best estimate of what the upcoming fiscal year looks like with respect to earnings. It is certainly reasonable to expect and require the company – which has chosen to invite the public to invest in its securities and thus in its prospects – to think seriously about the matter, and to develop an articulable view on it, as part of the company’s prudent strategic planning for its operations. It is logical, reasonable and fair to expect and require the latter as a condition of public company status.
Addressing Some Legitimate and Fair Concerns
If one has not previously thought about a change from quarterly to annual only periodic reporting, my proposal may be shocking and will likely cause much concern. When the initial shock wears off, however, I believe only the following three will remain as significant legitimate and fair concerns that arise because of my proposal. I believe my proposal answers each of them, but here they are initially without counter‑points.
First, what happens with material operating developments that become known by a company’s management during the current fiscal year, well before the time for the company’s next required annual disclosure of operating performance? Surely, no one benefits from (or should want) such information to be sprung upon an unsuspecting investment community and public in a year-end catharsis.
Second, what about the risk that information about such a development might leak, whether willfully or inadvertently, and be used by a select few to the detriment of the unsuspecting public? It would be naïve to expect that all such developments would remain truly “secret” for the possibly long periods of time that they may be known by a company before the end of its fiscal year.
Third, wouldn’t allowing a full fiscal year before operating performance disclosures are required simply invite (and give more time to orchestrate) all manner of skullduggery?
With respect to the first concern, my proposal would continue Form 8-K, which requires immediate disclosure about several types of events or developments. I believe the requirements of Form 8-K (with modest appropriate tweaking) can address effectively the first concern, without sliding back down the slope into full-blown quarterly operating disclosures. Also, the ongoing assessments aspect of the earnings guidance component would require prompt disclosure and an updating adjustment if any such development affects the earnings guidance that was provided for the current fiscal year.
With respect to the second concern, Regulation FD is an effective tool for regulating the leaking (or other selective disclosure) of information about interim developments, and it would be unchanged under my proposal. There is absolutely no basis for believing that Regulation FD would be less effective under my proposal. And, of course, private as well as administrative lawsuits remain as options to address and remediate unlawful trading on inside information.
With respect to the third (more general) concern, I agree that it is tautological that more time to hide something (or to dissemble with respect to it) increases the likelihood of success at doing so. However, I believe the greatest temptation for disclosure skullduggery is the shortness of the period for measuring and reporting operating results. Moreover, I believe that positing such unlawful behavior as an insurmountable risk of implementing my proposal would presuppose a level of inveterate unscrupulousness by corporate actors that is overly cynical and unwarranted. It would be tantamount to saying that unlawful behavior is innate, and so we should dispense with all law and embrace anarchy.
It is also reasonable to believe and expect that the year-end requirement for an independent audit of a company’s financial statements, along with the attendant year-end processes and the myriad corporate governance protocols imposed by the Sarbanes-Oxley Act, would still operate to help keep folk honest. And, there would be equal amounts of time, over the course of the fiscal year, for those processes to help ferret out possible skullduggery.
I have not conducted any surveys or other empirical investigations. But, over the course of 37 years of practice, I have represented and otherwise observed and interacted with hundreds of executives and directors of public companies and investors in such companies. On that substantial albeit anecdotal basis, I believe most executives and directors would applaud a movement to an annual periodic disclosure regime, after the possible taint of them being perceived as iconoclasts or mavericks has been removed. I also believe most small investors — the prototypical “moms and pops” who may be at the top of the heap of casualties under the current quarterly disclosure regimes — and most of the investing public generally would likewise recognize that eliminating quarterly disclosure of financial and other operating results can actually lead to more meaningful and useable information for their investment activity.
This post is only a summary of the discussions I plan for the article. In the article, I employ amusing metaphors and humor (or at least I try to) in presenting more detail about each of (a) the short-termism problem and malady afflicted by the current quarterly periodic reporting regimes, (b) the rationale for (and benefits of) my proposed change and (c) the broader context and history of our approach to public company disclosures. Many thanks if you have read this far. I am curious about your reactions, regardless of what they are.