Impact of Reporting Frequency on UK Public Companies: Profs. Robert Pozen, Suresh Nallareddy, and Shivaram Rajgopal Weigh In
The CFA Institute Research Foundation recently published a study examining the UK’s implementation of quarterly reporting requirements for public companies in 2007 – designed to foster increased transparency - and subsequent scrapping of these requirements seven years later in hopes of combatting perceived short-termism in UK equity markets and the misalignment of incentives throughout the investment chain.
At FCLT Global, we are examining alternatives to quarterly or short-term guidance in an effort to focus attention on long term metrics to foster a longer-term conversation between companies and their shareholders. Although guidance is clearly distinct from quarterly reporting, this UK experiment offers a fascinating look at the influence reporting frequency may have on public companies’ investment decisions and shareholder communications - and market participants’ resulting perceptions.
The study’s authors found the implementation of quarterly reporting produced:
- No material impact on the investment decisions of UK public companies, with ‘investment’ defined as spending related to three areas: capital expenditures (CAPEX), research and development (R&D), and/or net property, plant and equipment (PP&E). This is an important finding given the preference of investors for increased transparency.
- A preference for qualitative reporting: Companies adapting quarterly reporting (which did not require publication of financial metrics), were more likely to offer more qualitative comments in their disclosures, both on a quarterly basis and in other corporate communications. This confirms what many have long suspected: that when given the option, most companies prefer to discuss their business qualitatively, rather than via extensive quantitative disclosure.
- Increased financial guidance: Alongside the new quarterly disclosures, nearly half of those newly-mandated quarterly reporters also (voluntarily) initiated the practice of offering financial guidance.
- Better sell-side analyst coverage: Sell-side coverage of mandatory reporters increased during the seven-year reporting period; similarly, the accuracy of sell-side analyst estimates improved.
Observations & Takeaways
While it is difficult to pull apart the impact of qualitative vs. quantitative disclosures, the study raises important questions about the structure, content, and ultimate impact of shareholder communications. The UK reporting requirements did not mandate that companies report income statement or balance sheet data. Did this allow companies the space to be more thoughtful in the form and purpose of the shared disclosures, shifting the quarterly conversation toward longer-term performance and value creation?
An alternative way to examine this UK reporting experiment would be to expand the metrics used in the study, beyond CAPEX, R&D and net PP&E, to see how the results might change if ‘long-termism’ were evaluated by a broader set of metrics. In a paper published earlier this year by the McKinsey Global Institute, a five-factor Corporate Horizon Index (CHI) was used to measure a company’s long or short termism based on patterns of investment, growth, earnings quality and earnings management. Applying this more nuanced five-factor model may lend a new perspective to the study findings.
With work on our study of quarterly guidance policies and their impact on long-termism well underway, the author’s conclusions about guidance and sell-side estimates were especially relevant. It is worth considering whether forecast accuracy improved because analysts were better able to forecast company earnings as a result of the additional disclosure, or if companies now offering financial guidance felt more pressure to deliver reported earnings in line with this guidance and consensus estimates.
Companies closely managing their reported earnings to meet or beat consensus (and their own guidance) could also give the illusion of improved accuracy of analyst forecasts. Teasing that nuance out has important implications for the broader conversation about the usefulness and influence of quarterly guidance.
One encouraging finding was that the firms that subsequently dropped quarterly reporting after the mandate was repealed, analyst forecast accuracy did not deteriorate. This suggests analysts found other ways to refine company forecasts in the absence of more frequent reporting and financial guidance. This is an encouraging takeaway for companies, that eliminating quarterly guidance will result in unrealistic analyst expectations.
In light of this study, companies tasked with reporting quarterly should consider:
- ensuring metrics shared with investors are aligned with the company’s long-term goals;
- restructuring the quarterly public conversation to focus attention on measures of progress towards those goals.
Read the full CFA Institute Research Foundation study here.