USA TODAY US Edition
John Berlau and Chris Kuiper RACING TO ‘MAKE THE QUARTER’
Hillary Clinton’s right: ‘Quarterly capitalism’ is bad for business
“Quarterly capitalism” is a new focus of Hillary Clinton’s presidential campaign that could pick up even more steam with recent market turmoil. “It’s easy to try to cut costs by holding down or decreasing pay and other investments to inflate quarterly stock prices, but I would argue that’s bad for business in the long run,” Clinton said recently.
Some are saying this might be her way of sounding populist while maintaining support in the business community. But one need not support all of Clinton’s policy prescriptions, such as higher capital gains taxes, to agree with her that public companies racing to “make the quarter” can be a problem.
Yet Clinton and many other American critics of quarterly capitalism have ignored the proverbial elephant in the room — America’s mandate that public companies produce earnings reports every quarter. This rule underlies all the problems that go with it. International comparisons show that quarterly requirements not only tend to decrease long-term investment, but also increase manipulation of the numbers to please shareholders.
Since 1970, the Securities and Exchange Commission has required virtually all publicly traded firms to file 10- Qs every quarter, while most other countries require only public firms to file financial reports annually or semi-annually.
A memo just published by Martin Lipton, founding partner in the prominent corporate law firm Wachtell, Lipton, Rosen & Katz, asks U.S. policymakers to heed international calls for “the discontinuation of company quarterly reporting.”
For a short while, it seemed other countries would emulate U.S. policy, as quarterly reporting on the surface seemed to promote more transparency. In 2004, the European Union began to require public firms to transition toward quarterly reporting, partly to harmonize financial reporting with the U.S. Yet after outcries both from shareholders and firms — about the cost of the new mandates and concerns that they would lead to short-termism — the EU dropped these requirements in 2013.
Influencing the EU’s decision was a 2012 report from John Kay, respected business author and visiting professor at the London School of Economics. The Kay Review concluded that “quarterly earnings will be dominated by random fluctuations — or worse, will be managed to avoid them.” Kay cast doubt even on the effectiveness of annual company reports, arguing that for many companies, “profitability can be meaningfully assessed only over a period of many years.”
INVESTMENT FLEXIBILIT Y Other research confirms this:
An April study by Jurgen Ernstberger, professor of accounting at the TUM School of Management in Munich, finds that companies required to file EU quarterly reports were more likely to experience both a reduction in long-term performance and an increase in earnings manipulation relative to the performance of similar European firms before the mandate was in place.
A July study of the behavior of U.S. firms transitioning to quarterly reporting before the SEC’s mandate in 1970 comes to similar conclusions. Professors Rahul Vashishtha and Mohan Venkatachalam of Duke and Arthur Kraft of City University London find that mandates led to a 17%-19% decline in long-term investments.
Specialty grocery chain Trader Joe’s and convenience store chain QuikTrip have been praised by Clinton and others for their rejection of short-termism in their dealings with employees. The chains have long paid their workers above-average retail wages and provided extensive training, and have among the lowest turnover rates of U.S. retailers.
Yet there is a reason that these businesses might have the resources and flexibility to make these investments. Both are private companies subject neither to quarterly mandates nor other costly rules for public firms under laws such as Sarbanes- Oxley and Dodd-Frank.
The late John Shields, Trader Joe’s longtime CEO who pushed through many of the company’s pay practices, told an audience in 2010, “Those of you who are looking at going public, a psychiatrist should take a look at you.”
Abolishing mandatory quarterly reporting need not shut down frequent updating of shareholders on events affecting the firm. Public companies should be free to provide information as frequently as they like, provided that the information is accurate. It’s long past time for the U.S. to follow the EU and end the mandated quarterly numbers race so harmful to economic health.
John Berlau is a senior fellow at the Competitive Enterprise Institute. Chris Kuiper is a former research associate at CEI.