EXECUTIVES of publicly traded companies complain bitterly about American investors’ undue emphasis on short-term results. Yet paradoxically, two-thirds of the companies in the S.&P. 500 project what their next quarter’s earnings per share will be — and then spend huge amounts of time and resources in a dubious effort to meet that projection.
Evidence is mounting that giving what’s called quarterly guidance (for example, “next quarter the company is expected to earn $2.42 to $2.44 per share”) is detrimental to a company’s long-term performance. A survey by the National Bureau of Economic Research of 401 senior financial executives found that 80 percent were willing to forgo spending on research and development to meet their predictions, while 55 percent were willing, for the same reason, to delay projects that promise gains in the long term for their company.
Similarly, an empirical analysis of companies that regularly provide such guidance concluded that even though they are more likely to meet their projections than those that use the practice only occasionally, they are less likely to achieve long-term earnings growth.
This month, the United States Chamber of Commerce commission on which I serve will urge all public companies to stop giving quarterly guidance. Many chief executives will be reluctant; they fear that not issuing predictions will hurt their company’s stock price. These fears, however, are not supported by a 2006 McKinsey study of 1,200 companies that compared those giving quarterly guidance to those that did not. This study showed no statistically significant differences between guiders and non-guiders when it came to valuation multiples, stock price volatility and the number of analysts following the company. Trading volume did initially drop when a company abandoned the practice, but that difference disappeared within a year.
In fact, according to a membership survey by the CFA Institute, 76 percent of investment analysts who issue their own predictions about company earnings support the elimination of quarterly earnings guidance in favor of more extensive disclosures about long-term business strategies.
Yet most companies that stopped giving quarterly guidance did so because they missed their own projections and, according to a recent study by three business school professors, 25 percent of them resumed the practice as soon as their earnings improved. As a result, the stock market tends to view a company’s decision to stop as a negative signal about its future performance. That signal would be eliminated if more American companies announced a permanent end to the practice — ideally, immediately after a quarter in which the company met or exceeded its projections for earnings per share.
At the same time, the company should provide more information to the public in three key areas.
First, companies should disclose more on long-term plans for acquisitions or divestitures, capital expenditures and research investments.
Second, after companies disclose their actual earnings per share for the quarter, they should meet with Wall Street analysts to explain any mistaken assumptions or facts by analysts — and post the explanations on the company Web site. This practice was instituted by Exxon after it stopped giving quarterly earnings guidance.
Third, between quarterly disclosures of actual earnings, companies should publicly report, using the Securities and Exchange Commission’s expanded Form 8-K, any material changes in the company’s situation — an officer’s resignation, a significant patent victory, an accounting change — so investors aren’t taken by surprise.
If we want American companies to take a long-term approach, we must help chief executives free themselves from the tyranny of projecting quarterly earnings. Of course, American executives will still feel pressure to meet the Wall Street consensus on quarterly earnings. But that pressure will be much lower if company chiefs are not trying to meet their own public predictions.
Robert C. Pozen, an investment manager, is a member of the United States Chamber of Commerce’s Commission on the Regulation of the United States Capital Markets in the 21st Century.