A recent article in the National Post sets out a case “for ditching the quarterly financial report,” summed up by the headline: Quarterly earnings are mostly noise.
Written by Drew Hasselback, the article kicks off like this:
- Corporate governance experts have a simple suggestion for those worried about the adverse effect of “short-term” stock performance on long-term corporate health: Replace quarterly financial reports with a less frequent update, such as half-year results.
- The idea was raised last week during the annual conference of the Institute of Corporate Directors (ICD) in Toronto.
- Eileen Mercier, who is currently a director with Intact Financial Corp. and who has previously served as chair of the Ontario Teachers’ Pension Plan board, told a panel discussion that it’s time to consider whether quarterly financial reports actually mean anything. They might give analysts and financial reporters something to write about at least four times a year, but they don’t really provide investors with help in “price discovery,” she said.
- “We’re increasingly of the view that quarterly earnings are mostly noise,” she said. “I tend to think of the income statement in most industries as a work of fiction. It has become so complicated that most people can’t understand them or read them anyway.”
It isn’t a new train of thought. An interesting and thorough 2012 article on the ICAEW’s Economia website likewise asked whether quarterly reporting constitutes “too much information.” As summarized there, the arguments in its favour, in one way or another, all flow from the premise that “allowing companies to vanish off the radar for long periods of time can be dangerous. In the gaps between company reports, valuable information is more likely to be restricted to privileged investors that are closest to the firm.” But the article marshals a lot of ammunition in support of an opposing view. Among other things, an interviewee claims that quarterly reports “encourage companies to smooth out earnings…the idea that companies should be so predictable as to hit quarterly forecasts is simply an illusion.” Another thinks “the main effect is to encourage investors to churn their portfolios…there is an awful lot of worthless activity surrounding quarterly reports.” Yet another says: “Quarterly releases mean that some companies are in almost continuous reporting mode…that can put a lot of pressure on the finance functions of businesses and even impair the reliability of reports.” An economic study assesses that “the amount of value destroyed by firms striving to hit earnings targets exceeds the value lost in…high-profile fraud cases.”
This all leads to the following intriguing passage:
- “This raises the question of how corporate reporting could be changed if quarterly statements ceased to be obligatory. (Economist John) Kay believes a new approach to financial and business information is needed. “The notion that one size fits all for reporting is a myth,” he says. “The relevant time scales for businesses vary depending on the type of firm you are dealing with.” For example, banks can appear to be doing well in any particular year. But this might simply reflect the fact that they are taking on excessive risk, which only becomes apparent over the course of several years.
- “In this context quarterly reports would appear to be just a distraction. Firms with these very long cycles – such as those in banking, construction or energy production – could help investors more by offering comparisons of their performance at the same stage in the previous business cycle. This would not need to be updated each quarter.
- “By contrast, there are firms for which a quarterly approach might be extremely helpful, such as in retail. Differences in reporting frequency and style would be determined by the needs of investors rather than government rules.”
Hasselback’s new article makes the same general point: “Advocates of the move point out that it’s not about avoiding disclosure. Companies that move to half-year results could still release interim “trading” results to update shareholders on things like revenue performance.”
Put another way: given changes in technology, market speed and investor behaviour, why would we continue to assume a highly circumscribed, rigidly scheduled form of periodic reporting still makes sense in every circumstance? But as far as one can tell, there’s little appetite in Canada for such radical thinking. A few years ago, the Canadian Securities Administrators proposed the most modest of steps in this direction, to require venture issuers to prepare interim reports just once a year, at the six month point, rather than quarterly (IAS 34 sets out the principles and minimum content for entities preparing interim financial reports under IFRS, but leaves it to regulators in each jurisdiction to prescribe which entities should be required to publish such interim reports, or how often; many other jurisdictions only require six-monthly reporting, even for the largest entities).
But the CSA ended up dropping the idea, after receiving a mixed bag of comments, noting: “Commenters opposed to the original proposal thought the time period between financial reports would be too long and that the proposals might adversely affect the perception of venture issuers, their governance, liquidity and comparability to more senior issuers.” But that’s exactly why it was a good idea – investing in a development-stage mining company has almost nothing in common with investing in a bank, and that should be made as obvious as it can possibly be. Anyone who would be adversely affected from investing in such issuers by matters of “perception” shouldn’t be going near them in the first place.
Which leads to the main point – it’s hopeless to seek to save investors from themselves. If some investors think nothing short of quarterly information will do, then they can steer clear of entities that provide less than that. But that’s not a reason to force all issuers onto the same reporting treadmill…
The opinions expressed are solely those of the author