Semi­an­nual re­port­ing is still a bad idea and al­ways will be

Accounting Today - - Assurance - By Paul B.W. Miller and Paul R. Bahnson See SPIRIT on 21

Re­cent events have re­vived a long-dead idea that should have re­mained in the grave, specif­i­cally that there is great ben­e­fit in re­plac­ing quar­terly re­port­ing with semi­an­nual. The usual sus­pects, top man­agers of pub­lic cor­po­ra­tions, are re­spon­si­ble, and this time gained an ally in the White House. The seriousness of this ill-got­ten re­viv­i­fi­ca­tion is enough to bring us back mo­men­tar­ily and we’re hop­ing to put a wooden stake through its heart.

It’s fea­si­ble that it will take more than reprint­ing one of our columns to turn aside this un­wise move, but we think pre­sent­ing anew a 2015 es­say, “Build­ing Mu­tu­ally Ben­e­fi­cial Strate­gic Part­ner­ships with Cap­i­tal Mar­kets” will help do the trick. As a way of in­tro­duc­tion, we present once again the im­mutable and inar­guable four ax­ioms on which we have built our frame of ref­er­ence for re­shap­ing ac­count­ing pol­icy and reg­u­la­tion:

In­com­plete (also un­trust­wor­thy and in­fre­quent) in­for­ma­tion cre­ates un­cer­tainty for investors and the cap­i­tal mar­kets.

Un­cer­tainty in­creases risk for those investors and mar­kets.

Risk makes them de­mand higher rates of re­turn from the in­vest­ments.

That de­mand in­evitably pro­duces lower stock and bond prices as well as higher cap­i­tal costs for se­cu­rity is­suers.

There­fore, if man­agers and pub­lic pol­i­cy­mak­ers want to make things bet­ter for investors, the mar­kets, the whole econ­omy, and, yes, them­selves, this whole idea of semi­an­nual re­port­ing needs to be re­buried and left there.

As back­ground, the orig­i­nal col­umn was prompted by a pri­vate ef­fort of a con­sor­tium of CEOS who en­gaged a large law firm to plead their case that un­in­formed investors and mar­kets are somehow good for the rest of us, to which we said and still say, “Fuhged­dabout it!”

In early Septem­ber 2015, The Wall Street Jour­nal pub­lished a piece by David Benoit ti­tled “Time to End Quar­terly Re­ports, Law Firm Says” in which he re­ported that the “in­flu­en­tial law firm Wachtell, Lip­ton, Rosen & Katz has an idea that may be mu­sic to the ears of its big cor­po­rate clients and a night­mare for some investors and an­a­lysts: end quar­terly earn­ings re­ports.”

Cut­ting to the chase, this pro­posal to elim­i­nate quar­terly re­ports is to­tally wrong. In­stead of starv­ing investors by re­strict­ing the flow of in­for­ma­tion, man­agers need to trans­form them into well-in­formed strate­gic part­ners with in­ter­twined mu­tual in­ter­ests.

A sob story?

Benoit re­ports that Wachtell sent its pro­posal to the Se­cu­ri­ties and Ex­change Com­mis­sion in or­der “to com­bat what it and some oth­ers see as an ex­ces­sive fo­cus on short-term per­for­mance that they say has been en­cour­aged by ac­tivist share­hold­ers.”

In other words, the law firm’s at­tor­neys claim that cor­po­rate man­agers just can’t ex­e­cute long-term strate­gies be­cause their pesky own­ers keep in­ter­fer­ing. It fol­lows, but only in man­age­ment’s minds, that re­port­ing but twice a year will cre­ate a moat of si­lence that will keep the un­washed bar­bar­ians out of their hair.

Don’t your hearts just go out to those af­flicted and op­pressed ex­ec­u­tives who are forced against their wills to be ac­count­able for their poli­cies and out­comes? As we write, we’re wip­ing away a flood of tears. Of course, they aren’t brought on by sym­pa­thy but by our un­con­trol­lable laugh­ter … .

The idea of re­port­ing less fre­quently is not just non­sense. It’s not even com­plete non­sense. It’s ut­terly fool­ish and ab­so­lutely ab­surd non­sense.

Three bad premises

Wachtell’s pro­posal re­lies on three bad premises:

Cap­i­tal mar­kets are a nuisance in­stead of mu­tu­ally ben­e­fi­cial part­ners for con­verg­ing a stock’s mar­ket value on its real in­trin­sic value.

Cap­i­tal mar­kets make bet­ter de­ci­sions when they have lit­tle or no ac­cess to up-to-date first­hand in­for­ma­tion.

Man­agers can con­trol their stock price and cost of cap­i­tal by min­i­miz­ing how much they re­port in­stead of pro­vid­ing fre­quent, hon­est, clear and com­plete adult-level com­mu­ni­ca­tions about their real long-term plans.

We dis­man­tle these as­sump­tions be­low.

Mar­kets as part­ners

Back dur­ing the first two-thirds of the 20th cen­tury, most man­agers saw them­selves locked in bat­tle with four dif­fer­ent mar­kets:

La­bor mar­kets: They be­lieved the only way to get em­ploy­ees to work hard was through pres­sure and in­tim­i­da­tion.

Out­put mar­kets: They as­sumed cus­tomers would ea­gerly buy what­ever their com­pa­nies pro­duced.

In­put mar­kets: They were con­vinced their sup­ply chain mem­bers were so priv­i­leged to be do­ing busi­ness with their com­pa­nies that they could be brow-beaten into con­ced­ing rock-bot­tom price re­duc­tions.

Cap­i­tal mar­kets: They be­lieved they had free rein to man­age any way they pleased be­cause investors lacked the power to re­strain them.

No­tably, events over the fi­nal third of the cen­tury sig­nif­i­cantly changed their re­la­tion­ships with three of these mar­kets.

The first thing to crum­ble was their con­de­scend­ing at­ti­tude to­ward la­bor af­ter the con­cepts of hu­man re­source man­age­ment made it clear that em­ploy­ees are more likely to be loyal and pro­duc­tive when they’re nur­tured, chal­lenged and re­warded, in­stead of threat­ened.

Next, their pre­sump­tive at­ti­tude to­ward cus­tomers col­lapsed when the suc­cess of Ja­pan and Europe in ap­ply­ing To­tal Qual­ity Man­age­ment proved that a com­pany must com­pletely sat­isfy their needs or lose them to some­one who does.

Fi­nally, man­agers’ dom­i­neer­ing at­ti­tude to­ward their sup­ply chains va­por­ized when Ja­panese man­u­fac­tur­ers reaped ex­tra­or­di­nary ben­e­fits from just-in-time tech­niques. Close col­lab­o­ra­tion all up and down the chain en­sures that in­puts ar­rive on time and meet the qual­ity stan­dards needed to keep the line mov­ing.

In sum­mary, com­pa­nies’ re­la­tion­ships with these three mar­kets evolved 180 de­grees away from ex­ploita­tion and con­flict to be­come mu­tu­ally ben­e­fi­cial part­ner­ships that help both par­ties.

Alas, though, to­day’s man­age­ment corps doesn’t seem to have ever pon­dered whether they would be bet­ter off if they de­vel­oped sim­i­lar closely aligned re­la­tion­ships with the cap­i­tal mar­kets.

As we un­der­stand it, these mar­kets de­mand only two things from man­agers: pos­si­ble fu­ture cash flows, and use­ful in­for­ma­tion for as­sess­ing those cash flows’

Paul B. W. Miller is an emer­i­tus pro­fes­sor at the Univer­sity of Colorado at Colorado Springs and Paul R. Bahnson is a pro­fes­sor at Boise State Univer­sity. Reach them at pauland­[email protected]

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