Critics of quarterly reporting argue that it creates an overemphasis on short-term results that creates behaviors that can be damaging to companies and their investors in a number of ways. They argue that it can unduly focus companies on managing quarter-to-quarter reported results rather than on developing and implementing strategies and actions that create growth, increased profitability, and value creation over the longer term.
The outcome of this is that over time the performance of a company is the result of a series of its short-term actions and not of a cohesive strategy aimed at building growth, profitability, and corporate value. The critics also believe that this short-term focus can promote inappropriate earnings management and accounting abuses by corporate managers who view “making the numbers” as critical to meeting the “Street’s “expectations in order to maintain the price of their company’s stock and its image and credibility with investors and the capital markets. Thus, in order to make the quarterly numbers companies may take actions such as reducing expenditures of research and development and marketing that, while improving short-term earnings, can stunt growth and profits over the longer term.
At the extreme, managers may resort to accounting gimmicks and rules violations to increase quarterly reported results that when detected by auditors or regulators result in painful restatements that can severely damage the company, its investors, employees, and other stakeholders. Company managements, board of directors, and investors with a longer-term investment horizon may also be concerned that quarterly reporting and the behaviors it engenders play into the hands of short-term traders and activist hedge funds looking to profit from short term swings in a company’s stock price. And critics argue that the quarterly reporting is costly and arduous and that this burden falls disproportionately on the thousands of smaller U.S. public companies.
In my view the focus should be on preserving the benefits of quarterly reporting in ways that help avoid or mitigate the potential harmful effects. So to me, it is less about the frequency of reporting and more about what gets reported and how interim results should be interpreted in the context of a company’s longer-range objectives, strategies, and prospects.
On the other hand, defenders of quarterly reporting see it as important to the transparency and health of our public capital markets. They believe that the requirement to report regularly results in greater discipline and improved controls over financial reporting at companies and better and more timely information for investors. Some also believe that if companies had to report less frequently, say annually or semi-annually, there would be greater scope for earnings management and accounting abuses. And in the absence of specific quarterly reporting requirements, companies might choose to cherry pick and selectively disclose only positive interim information to the market. Supporters of quarterly reporting also argue that in its absence investors, financial analysts, and the business press will find other ways to try to find out how a company is doing, ways that would invariably yield less reliable and potentially speculative information. The result, they maintain, would be less informed investment decisions, greater volatility in stock prices, and less efficient allocation of capital across the markets.
So who is right?
I think there is truth in both sets of arguments and that we see real-world evidence of both the pros and cons of quarterly reporting. On the positive side, quarterly reporting requirements promote enhanced internal controls and closing processes at public companies, including for example, the review of the quarterly information by senior management, internal disclosure committees, and the independent auditors and in more timely information to investors and the markets. But on the negative side, we certainly have seen, for example in SEC enforcement releases, many examples of companies using various short-term maneuvers and accounting abuses in an effort to make the quarterly numbers.
While such actions to prop up reported short-term results can have damaging effects on a company’s longer-term prospects, that does not mean that we should abandon quarterly reporting. Rather, in my view the focus should be on preserving the benefits of quarterly reporting in ways that help avoid or mitigate the potential harmful effects. So to me, it is less about the frequency of reporting and more about what gets reported and how interim results should be interpreted in the context of a company’s longer-range objectives, strategies, and prospects.
To draw a sports analogy, for example, to professional baseball or football, there is play-by-play reporting of games as they are occurring and reporting of “interim” results such as the score at the end of each inning or quarter. As spectators, we understand how these all fit into the context of the objective of winning the game. And over a season, we understand how a team’s win-lose record and standing in its league table contributes to its goal of making the playoffs and then how the results of games in the playoffs affect the ultimate objective of winning the World Series or the Super Bowl. While the analogy to sports may be an imperfect one—because in sports the ultimate objectives are clear and laid down by the rules of the game and league competition—the point is that there is very frequent reporting of interim performance that can be understood and interpreted in the context of the ultimate longer-term objectives.
Turning back to the realm of corporate reporting, quarterly earnings and financial reports are very important. But it is often difficult to understand, interpret, and assess a company’s quarterly and annual results in terms of longer-range objectives and performance. This may occur for many reasons, for example, because the company has not developed a clear set of longer-term performance objectives, the strategies to achieve them, and how interim reported results and other reported metrics relate to the longer-term objectives. And even where a company has addressed all these matters, it may not be clearly communicating them to investors and financial analysts.
Additionally, many studies have shown that over the long term a company’s growth, profitability, and value are significantly impacted by the strategies and actions it takes on key “non-financial” areas relating, for example, to human capital, customer satisfaction, innovation, and material environmental, social, and governance (ESG) issues. These studies also indicate that companies that do identify, measure, and report these matters tend to outperform their peers over the long term in terms of financial results, lower cost of capital, and greater stock price appreciation. That may well be because it better enables them to pursue longer-range objectives, strategies, and actions and to better communicate how short-term reported results should be viewed and interpreted in the context of the longer-tem goals.
I have been trying to advance this line of thinking for many years going back to my pre-FASB days at PwC where I coauthored the book The Value Reporting Revolution; Moving Beyond the Earnings Game that discussed deficiencies in the reporting system, including the quarterly “earnings game” and called for reforms to enhance the organization, content, and delivery of corporate financial and non-financial information. These ideas have been developed further and are now embodied in the integrated reporting movement and in the work of organizations such as the Sustainability Accounting Standards Board.
The goal is not to supplant financial reporting or to increase the compliance burden on companies, but rather to better focus corporate reporting on the matters that drive long-term performance and sustainability and that can facilitate a better understanding and evaluation of short-term reported results against longer-term objectives. I believe this can help mitigate the potential undesirable effects of quarterly reporting, help promote better performance by companies over the long run, and help investors make more informed investments decisions. The answer is not to do away with quarterly reporting, but to better align it and our whole reporting system with the pursuit of longer-term objectives and strategies.