Earnings Reporting: How Often Is Too Often?BloombergQuintOpinion
You may like him or hate him, but you cannot ignore Donald Trump, especially his tweets. The recent one to create considerable interest among investors and businesses is one on corporate earnings announcements.
Is it one more proposal that looks outlandish and out-of-the-box? Certainly does not seem so from the face of it, as this has been a topic of debate amongst academics, corporates, investors, and regulators for some time now. Hillary Clinton had also highlighted the need to change the regulations on earnings reporting during her presidential campaign. Australia and some countries in the European Union do not mandate quarterly reports but focus on six-monthly reports. What does it mean for India? Should India also think along the same lines of abolishing quarterly earnings reports?
Before delving to pronounce a judgment, let us look at the pros and cons of a quarterly reporting system. Clearly, quarterly reports bridge the information asymmetry between the management and investors.
In the absence of quarterly information, investors would be left guessing about the impact of commodity price movements, the success of the launch of new products or the impact of changes in macroeconomic parameters on company’s profitability.
The quarterly earnings announcement enables investors to react to the performance of the company based on actual results. This becomes especially important for analysts, hedge funds, and short-term investors. Especially in times when regulators are finding ways to safeguard against frauds and misrepresentation, quarterly earnings announcement becomes an additional tool.
However, the opponents of quarterly earnings argue that announcement of quarterly earnings sucks a lot of senior management bandwidth, impacting their ability to focus on long-term strategic issues. It also encourages a short-term focus the part of the management, as they tend to avoid shocks and smoothen results on a quarterly basis. They argue that it often leads to sub-optimal decisions on capital investment. As a result, we would be building corporates which are looking good today but are not building sustainable businesses. Quarterly reporting also adds to the substantial cost of compliance. Yes, there is merit in these arguments too.
Paul Polman scrapped the practice of quarterly earnings reports at Unilever, the day he became the chief executive officer.
He was clear that he welcomed only long-term investors to invest in Unilever.
In 2013, European Commission amended its Transparency Directive to abolish the requirement of announcing quarterly reports for public limited companies, and as a result, most of the companies have moved to a six-monthly earnings report.
Even some long-term influential investors like Legal & General Investment Management and Schroders have run campaigns to persuade the companies in which they invest to end quarterly reporting even if the company wanted to announce the quarterly results. They believe that quarterly earnings only helps short-term investors such as hedge funds and algorithms, who benefit from short-term volatilities around quarterly results.
During my interaction with investors, many long-term investors start with the introduction that they are not bothered about quarterly results, and are focused on the long-term strategy of the company.
They would use the quarterly result as some sort of signpost to understand whether the company’s fundamentals and risk profile and any major valuation assumptions are changing rather than to make decisions based on margin reported in that quarter.
There is not much evidence to indicate that the management focus changes to short-term by adopting quarterly reporting, as studies in this area are scant.
One study of European companies—by Professors Suresh Nallareddy, Robert Pozen, and Shivaram Rajgopal—found no evidence to substantiate the argument that a corporation’s investment pattern changes once it shifted to quarterly reporting.
In my view, moving from quarterly to six-monthly may not necessarily refocus the management orientation as six months is still short term.
Therefore, is abolishing quarterly reporting good or bad? I feel that the question should be asked differently – how do we balance between the need for investors to understand the company’s performance in a timely manner and the cost of frequent reporting. There is no doubt that quarterly earnings reports should be made less complex and less time consuming for the management.
As a CFO of a large company, I am already staring at the next big challenge – quarterly reports at a consolidated level from next year.
If we have to continue with quarterly reporting, can we look at simplifying the process of quarterly earnings announcements? The current regulations require one to publish quarterly results (at consolidated levels from the financial year 2019-20 onwards) after being subjected to limited review by statutory auditors. Can the same be simplified to be reported at a stand-alone level and based on self-certification of the management? The annual statements can be subjected to a full review by statutory auditors. Also, quarterly statements can be focused on performance related to operational performance rather than to include mark-to-market changes that would require elaborate valuation and those that get reversed eventually during the year.
For example, in the automobile, farm equipment industry, we report volumes of cars and commercial vehicles and tractors every month, which provides a very good proxy for assessing the company’s performance. Also, under SEBI’s Listing Obligations and Disclosure Requirements, Indian listed companies are obliged to report any information or event that is material in nature. There are also strong regulations on responding to market rumours and dealing with unpublished price sensitive information.
Therefore, investors in Indian equities will be able to get a very good understanding of business performance even without stringent quarterly earnings reporting requirements.
In conclusion, I would argue that companies should have the freedom to report quarterly performance based on key performance indicators and move to a half-yearly earnings announcement regime. This, I believe, would balance the need for timely information as well as reduce the compliance complexity and cost, and release top management bandwidth for more strategic issues.
VS Parthasarathy is the Group CFO at the Mahindra Group.
The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.