Research has consistently found that the vast majority of corporate executives think that short-term pressure is changing their business decisions and harming long-term value. Recent work from FCLTGlobal has shown that an effective way to combat this phenomenon is by moving away from quarterly guidance.
After calls from the White House and American business leaders in the latter half of 2018 to reexamine the standards for corporate guidance and reporting in American business, the U.S. Securities and Exchange Commission has requested public comment on how to enhance the investor protection attributes of periodic disclosures while, among other things, reducing short-term pressures caused by the current pace of corporate reporting.
In light of our in-depth analysis of the issue, FCLTGlobal recently submitted a full comment in response to the SEC’s request, grounded in in-depth analysis and informed by multiyear conversations with our Members and other experts.
The SEC’s request for comment explores both earnings guidance and financial reporting. Our response includes three recommendations for the future of each practice, progressing from relatively straightforward actions to more substantial policy shifts.
- The SEC could issue a Staff Compliance and Disclosure Interpretation (C&DI) or other Staff commentary clarifying that short-term quarterly guidance is neither required nor encouraged. This would dispel the commonly held misconception that quarterly guidance is a legal requirement for publicly listed companies. (C&DIs are not rules or regulation, but rather intended as general guidance.)
- The SEC could issue a similar recommendation that if a company chooses to share short-term quarterly guidance, it should also offer long-term (3+ years) guidance to balance the impact.
- Going one step further, the SEC could mandate that if a company chooses to offer short-term quarterly guidance it would be required to balance it with long-term (3+ years) guidance.
- The SEC could permit or recommend cumulative reporting (3 months, 6 months, 9 months, 1 year) or trailing twelve-month reporting. This would maintain the transparency of a frequent reporting schedule while avoiding some of the unintended consequences of quarter-to-quarter comparisons.
- The SEC could allow companies to choose between disclosure frameworks, giving them the option to stick with the current quarterly reporting schedule or move to half-yearly reporting, provided they adopt a higher bar for interim disclosure of new material information. Such continuous reporting models are currently in use in the United Kingdom and the European Union.
- The SEC could consider a third model: full financials and related reporting on a six-month basis (2Q and year-end) with abbreviated interim trading updates (1Q and 3Q) to alleviate the reporting burden on public companies while still maintaining investor transparency. This model would align U.S. reporting requirements with other developed markets.
Several other notable organizations, including FCLTGlobal Members, also weighed in on the SEC’s request. A common thread among them all was an identification of guidance, rather than reporting, as a root cause of systemic short-termism.
BlackRock: “Forward looking guidance, while appropriate in some circumstances, has the potential to focus management too much on a short term deliverable and not enough on a long term, sustainable strategy for driving business growth. This short term focus runs counter to the approach we follow as a fiduciary in our engagement with portfolio companies, which is to ask every CEO to articulate for shareholders a strategic framework for long-term value creation and report annually how the company is performing within such framework.”
Council of Institutional Investors: “CII believes that quarterly earnings guidance can have negative effects on investors, companies and capital markets. We see forward-looking guidance, which by definition is predictive and speculative, as very different from historical reporting on what has actually taken place. From discussions we have had with various market participants, we think there is considerable confusion on this distinction.”
Nasdaq: “We received feedback from 187 companies regarding the cost, content and timing of quarterly reports and their perspectives on long-term and short-term investing. […] 76% of survey participants also support ending the practice of quarterly earnings guidance[.]”
The National Association of Corporate Directors: “NACD recommends that the SEC disallow earnings guidance […] NACD has spoken against the practice of earnings guidance. [Our] report noted that ‘the business media echo-chamber can amplify a one- or two-cent difference between a company’s actual results and the company’s published guidance . . . into predictions of imminent success or failure.’ To avoid this fate, noted the report, some companies sacrifice value to make their earnings targets—that is, to fulfill the prophecy made in their earnings guidance.”
Sullivan and Cromwell: “We don't think that quarterly reporting of historical earnings information, in itself, is a significant contributor to the problem of "short-termism". For one thing, reporting companies' managements and boards will continue to have this quarterly information, whether or not they release it publicly. A much more significant contributor to "short-termism", we think, is companies' practices with respect to providing earnings guidance, and then focusing their reporting on that guidance.”
AFL-CIO: “We acknowledge that an excessive focus on short-term financial results is a real concern for corporate issuers and investors. However, we do not believe that short-termism is caused by mandatory quarterly financial reporting. Rather, the myopic focus on quarterly earnings is driven in large part by the perceived need for corporate issuers to achieve earnings guidance targets.”
FCLTGlobal is excited to have an opportunity to contribute to the dialogue around reporting and guidance practices. Submitting our feedback on this important issue allows us to bring some of our cornerstone research into more widespread acceptance and practice. We look forward to seeing the impact the SEC’s next steps will have on the long-term health of capital markets and the American economy. If you’d like to discuss our comments in greater detail, please contact us at [email protected].