Semiannual reporting is still a bad idea and always will be
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]