Maybe it is just because I used to be an auditor and am very familiar with financial reporting, but I never seem to stop hearing about how horrible it is that companies have to report their earnings every quarter. The common refrain is that quarterly reporting encourages myopic thinking and makes executives focus on the “short term” rather than invest in long term projects that supposedly could increase America’s competitiveness.
But here, right in our faces, is a clear example of the benefits of quarterly reporting. The CDO market has “seized up”, tied to a liquidity crisis in the credit market which manifests itself in the home mortgage business. In laymans’ terms, the marginal borrowers can’t buy homes, the “packagers” of CDO’s can sell the mortgages to third parties, and the companies that make fees from this process or were sitting on inventory when the music stopped (just like “duck, duck, goose”) all were screwed.
What happened? Well, if companies didn’t have to report earnings quarterly, not much would have happened. Sure, it looks like losses are there for the taking IF companies have to sell now, but an annual reporting company (only) would “hold out” and wait for the markets to turn, if they didn’t have to “fess up” and report their losses on a quarterly basis (tied to an audit with an external accounting firm that has a lot in stake in not approving the financial statements for a company that subsequently “goes bust”).
But companies DID have to report their earnings quarterly. And what happened? The head of Merrill Lynch, O’Neal, had to resign. The head of Citicorp, Prince, had to resign. And other companies had to cough up billions and billions of dollars in losses tied to these investments, with the potential of more to come. So far over $30 billion has been written down, and loss estimates range as high as $500 billion per a WSJ article called “Carnage Estimate in Fixed-Income”
It isn’t true that quarterly reporting causes companies to shun long term investments. If this is true, why did the market keep funding internet and bio-tech start ups, that run up losses every quarter? This is because the market can listen to management and see the long term, as well as assess the risk that this never happens.
A few months from now when you hear someone reflexively criticize the “short term” view of quarterly earnings, ask them if you think O’Neal and Prince would have “come clean” about their losses and faced up to them, or held on to their jobs that much longer? I know my answer.
Cross posted at LIGTM
I think that a quarterly balance sheet is a good snapshot of a company’s finances, and the market weights that information against the historical trends, debt leverage, industry analysis and news and quickly decides whether the company is a keeper or not.
But we live in such an information age that by the time a corporate office in Chicago sees, at the of the day, how sales of their product are behaving in Mexico or Japan or how these markets are responding to their services, it is possible that the stock market had already guessed it almost exactly based on accurate historical trends and other information they are also getting and they have already taken your P & L’s into the ecuation.
Companies produce very exact daily, weekly and monthly reports so that managers can take corrective decisions in almost real time.
Trends can be viewed on a hourly, daily, weekly and monthly basis, one year is already too long for the market to work.
Company managers today are hard pressed between having to show good results at the end of the quarter and at the same time having a long-term growth plan. But markets are also mature enough to understand these issues and are train to keep an eye in long term potential.
I think the question is probably how long are we going to continue issuing quarterly reports before we are demanded to cut it down to monthly reports. After all, the market only wants is to know how predictable you company can be.
Periodic summations in general have the interesting effect of creating pulses of information that move through decision-making networks like a pig through a python. People respond to these lumps of information differently than they respond a continuous stream of information that flows in over the same time period even if both sources contain the same information.
The need to report at arbitrary times also distorts the behavior of organizations as people try to accelerate or decelerate some activity in order to improve their numbers.
Things would be better if we could process organizational information as a continuous stream but even with computers I don’t think that will be possible anytime soon.
A couple of things that may tend to support your view:
1)In their excellent book, The Innovator’s Solution, Christensen and Raynor argue that it is very important, when establishing internal corporate ventures, to focus on early profitability, not just revenue growth.
2)In an experiment, students in a ceramics class were divided into two groups, one told it would be graded only on quality and the other told it would be graded only on quantity. Guess which group produced the highest-quality work?
Note also that when businesses operate outside the public markets (private equity, venture capital) there is still periodic reporting, usually quarterly. It’s just that the audience is smaller and (presumably) more knowledgeable about the business.
I think there definitely *is* a problem with market overreactions to small fluctuations is quartery earnings, but the problem is caused less by the quarterly reporting than by:
1)The presence in the market of many very-short-term investors
2)The presence in the market of many investors who really don’t understand the particular business in any depth, and can assess only quantitative information.
3)The growing role of computer-based investing approaches, which by their very nature can only look at quantitative data.