July 28, 2006

Hubbub Over Quarterly Earnings Guidance

Some pretty interesting commentary in the wake of Monday’s Symposium sponsored by the CFA Centre for Financial Market Integrity and the Business Roundtable. During the Symposium, three principal messages were imparted: (1) companies should cease providing earnings guidance, (2) they should tie executive portfolio manager performance (and disclosure thereof) to long term metrics, and (3) they should provide greater communication and disclosure of long term strategies and metrics of long term value creation.

We have posted a summary of the Symposium proceedings in our “Earnings Releases” Practice Area. And it’s probably about time for me to re-do this survey on earnings release practices and see what the results would look like now. Here is a more recent survey from McKinsey.

According to this WSJ article, SEC Chairman Cox said that these calls for companies to stop issuing quarterly earnings guidance are “healthy recommendations.” And the WSJ reports that former SEC Chairman Bill Donaldson supports efforts to get companies to stop issuing quarterly earnings estimates, but that he warned groups pushing the issue Tuesday that any move in that direction should be balanced by increased disclosure of other factors, like long-term strategic goals.

But in an editorial from the Financial Times entitled “Misguided Guidance,” a different perspective is presented. Below is the FT editorial:

“When both company bosses and fund managers agree that quarterly earnings forecasts harm US business it is time to listen. The Business Round-table Institute for Corporate Ethics and the CFA Institute say in a new report that the practice “leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns, and impeding efforts to strengthen corporate governance”. None of those consequences is good.

The investment community has, in effect, been asking companies to lie to them four times a year. Few investment projects deliver a return inside three months. Investments by an oil company in a new production field take decades and a quarterly forecast means nothing. What is worse, as any schoolboy will tell you, is that lies once told are not forgotten. Quarterly forecasts can only be met if a company is managed toward them. Pressure to hit quarterly numbers is one factor behind the culture of lies that devoured Enron.

It would be unfortunate, though, if efforts at reform made companies less open and transparent. Financial markets breathe information and forward-looking information is especially pure oxygen. Reform that increases investors’ uncertainty over corporate prospects would harm investment returns just as surely as quarterly guidance. Nor should formal guidance be replaced by unofficial numbers, delivered to a favoured analyst over an expense account lunch. Privileged access to information was a feature of the dot-com era now rightly discarded.

Rather than starve the markets of information, companies should think afresh about what guidance best reflects their business, and how they give it. Investors want to know how much oil Shell will produce in 10 years’ time. They want to know how Microsoft will deal with the competitive threat from Google. From small technology companies, however, which need to raise more capital, they want regular information about prospects. It is short-term guidance, not forecasting hard numbers, which causes the problem. In Japan, not known for a short-term outlook, all listed companies must forecast their turnover and profit for the year ahead.

The victims of scrapping quarterly guidance will be the financial journalists, sell-side analysts and hedge fund traders who profit from the use, abuse and interpretation of news. Their hunger for information has made it hard for any company, particularly a small company, to unilaterally end quarterly guidance, when it knows that doing so will mean less media coverage, less analysis and less liquidity in its shares. Companies have to be careful that stopping quarterly guidance is not seen as an attempt to cover up bad news.

Now, though, US corporations have the opportunity to guide their investors in a new direction. It is an opportunity they should embrace.” Read more commentary in the “AAO Weblog” and the “D&O Diary.”

I’ll Trade You a Jeff Skilling for Two Dennis Kozlowskis

As the fourth anniversary of Sarbanes-Oxley approaches this Sunday, July 30th, it may be interesting to take a look back over the past four years to see how the legislation has affected businesses across the country. Yeah right – I would rather have a little Friday fun…

I was a big baseball card nut when I was a kid. So I shed a tear or two when I saw this deck of trading cards from the Slate with all the stars from this generation’s corporate scandals (click on the cards to see them up close; the backs of the cards are hilarious). You can even recognize some of the borders as mimicking old Topps sets. Thanks to Andy Gerber for the heads up!

Con Artist Obtains Shareholder Data from ADP

There have been so many reported instances of security breaches at companies by hacking or an employee simply leaving a laptop in a cab, it was almost comforting to read about ADP being conned by an impersonator. According to media reports, including yesterday’s WSJ, ADP gave shareholder lists to “an unauthorized party” who impersonated numerous corporate officers between November 2005 and February 2006.

The information provided included names, addresses and number of shares owned by individual investors, but did not include account numbers, social security numbers or identify the brokers where shares were held. I’m not sure which particular companies were targeted as media reports don’t disclose that information – for example, this older WSJ article only says:

“Fidelity Investments said 125,000 of its customers were among those whose information was breached. UBS AG said about 10,000 of its customers were affected, while Morgan Stanley said about 3,800 of its clients were affected.”