Now the Generation Foundation — the advocacy part of Generation Investment Management — has produced a detailed study that comes down even harder against too-frequent reporting. It says that issuing regular short-term earnings guidance could actually be damaging for the business by undermining corporate performance in the longer term.
“There is a strongly held belief that the provision of regular earning guidance reflects good corporate governance and best-practice investor relations,” it says. “However, this report makes clear the damaging effect that earnings guidance can have on corporate performance and long-term investor returns.”
It lists several reasons why. First, companies issue guidance on what they expect their profits to be, then get themselves locked into delivering that number. Meeting the short-term forecast becomes the primary objective of the business. Normal activities are distorted so they fall as desired inside or outside the relevant reporting period. Long-term strategy is sidelined if it looks as if it will get in the way of delivering the required level of quarterly profit. The flexibility of the business is compromised, the normal ebb and flow of activity needlessly distorted.
Second, just as management is distracted, so too are the investors. When all the attention is focused on quarterly numbers, the investment community finds it hard to think clearly about where the business is going in the longer term. So short-term numbers encourage investors whose horizons are similarly short-term.
Third, the report even suggests that short-term forecasts encourage insider trading. Certainly executives become aware of the times of the year — normally just after, rather than before, profit announcements — when they are allowed to deal in shares or exercise their stock options. It says: “Corporates may indulge in questionable practices which are not in the long-term interests of the company in order to move the share price to maximise the executive’s personal benefit.” Some might think this a bit harsh but incentives do drive behaviour.
The fourth problem is the analysts. Some are quite knowledgeable but they have little chance to show that knowledge or differentiate themselves from their less-gifted colleagues when all they ever do is predict and comment on quarterly numbers. How much better if they were freed up to think about the longer-term tasks facing the company and challenge management accordingly.
While not necessarily agreeing with all the opinions expressed above, there is no doubt that growing numbers of companies think quarterly reporting gives all the wrong signals. It is a view shared by some of the regulators here, too — although less so elsewhere in the EU. Perhaps it is time for those charged with these matters to initiate a proper conversation to find a way to get off this particular treadmill.
Practical lesson in being efficient
One reason the shake-out in emerging markets has been so bad is that their companies have been less successful than those in the West at coping with adverse economic conditions.
Companies in developed markets have been unusually successful at maintaining their profit margins even when top-line growth has faltered. In contrast, the profit margins of companies based in emerging markets have come under much more pressure.
This is a surprise in that, in the age of globalisation and international executives, one might expect management skills and techniques to have become pretty well standardised around the world. However, if this were the case, you would think companies would react to adversity in similar ways, and this has not happened.
Sensing on opportunity, the Chartered Institute of Management Accountants has, in conjunction with its American equivalent, seized the moment to draft and launch the first-ever set of international management accounting standards. These, one should say straight away, are not to be confused with the financial reporting standards that have been around for years — management accounting is far more useful.
It could be likened to the electrodes that are attached to your body in a medical so the doctor can monitor in real time your heartbeat, breathing, blood pressure and temperature. Financial reporting in contrast is the document produced by the doctor after your medical which says how much heavier you are than last year, how your fitness has gone to the dogs and your cholesterol through the roof.
The reality is that good management is impossible without good management accounting because it is the only way those in charge can know accurately what is happening in the business, ideally more or less as it happens. And good management accounting is surprisingly thin on the ground — some companies do a small amount very well; some do a large amount not very well, few are as good as they could be in all departments.
Thus the need for objective standards, the purpose of which are to show management what good looks like and to allow it to see how its own systems measure up. Where there are gaps, they can see how to improve and the result should be a general improvement in business efficiency.
Glamorous it is not, but you can see it is the kind of practical, down-to-earth innovation executives could find to be genuinely useful.