I should be a prime candidate to support the lengthening of the financial reporting cycle from three to six months, as the White House—and many others—now say they want the SEC to do. I want public corporations to be more sustainable and managed for the long run and doubt that they currently are to a sufficient degree. America and the world need large firms willing and able to build for a shared future, not just deliver dividends and capital gains to investors in the here and now.
So if I thought that going to semi-annual reporting would move the markets in that direction, I’d be cheering. But I’m not. It’s not because there is anything magically right about quarterly reporting. Fundamental valuation models are supposed to project earnings well into the future, adjust for risk, and discount to present value. What happened for the issuer in the last three months is a noisy indicator of that future, especially when filtered through the artificial conventions of acceptable accounting. I can’t imagine that six months is all that much better, however.
Much has been written about short-termism. I cast my lot, for what it’s worth, with the idea that market prices do have a myopic bias. This is not out of mindless short-sightedness on the part of investors and portfolio managers (though there is some of that) but rather because in today’s fast-paced world of innovation and disruption, the fundamental value embedded in the long-term future is so uncertain. Companies like Apple that can credibly make a sustained value proposition do get a stock price boost from it. But most can’t, and instead get something of a lemons discount applied to their projections of a bountiful future. That is not a slap at management, though I’m sure that managers tend (with an excessive sense of self-efficacy) to think their firms deserve higher valuations than they get. It’s just that there is too much fog to see that far ahead. And so analysts and portfolio managers look instead to shorter-term market opportunities for an edge. The resulting scramble is not healthy—managers trying to manage expectations, savvy investors investing more in short-horizon trading technology, etc.
Moving from a three to a six month reporting cycle wouldn’t change this dynamic very much, if at all. Without any greater insight into the longer term, the bias in investor attention will remain on the more knowable near term, now with more uncertainty because of the longer gap between the dates for financial reckoning. That is not going to help firms’ cost of capital and could cause some analysts to lose interest altogether in doing the costly work of following smaller public companies. There will be more pressure on issuers to give interim guidance, either publicly or (Regulation FD notwithstanding) through back channels. And as everyone who has criticized this proposal has pointed out, the opportunities and temptations for insider trading in all its imaginative forms will rise if real-time voluntary disclosures don’t adequately fill the gap.
Most of the attention on the reform proposal has focused on the financial reports themselves and key accounting metrics like earnings per share. But the 10-Q also requires management’s assessment of trends and uncertainties that are reasonably likely to occur, as an early warning device of looming risks that make reliance on recent past financial performance imprudent (the MD&A). The MD&A requirement is far from optimal, but research shows that it has value to investors, and it is effectively all we have to require public companies to alert the market to sensitive forward-looking matters in a timely fashion. In a world where risks pop up so fast, limiting this kind of risk disclosure to every six months is absurd.
All in all, I think the information environment will be degraded by a move to semi-annual reporting. Not catastrophically so, largely because issuer disclosure practices would presumably adjust to meet market pressures. But for exactly that reason, benefits would also be modest. Quarterly filings are costly, but the financial reporting and disclosure apparatus needs to operate on a continuous basis for a variety of reasons, and so two filings a year rather than four will not really mean major cost savings. Back in the aftermath of the Enron and WorldCom scandals, policy-makers decided that more on-going management attention to disclosure quality and internal controls was a good idea. Especially as to big firms with a large footprint on our economy, nothing has happened to say that they were wrong.
This is not the place to debate better ways of overcoming short-termism, most of which have nothing to do with disclosure or its frequency. I do think there is promise in the move toward developing better disclosure metrics for sustainability reporting. Most of the problems, however, are deeply structural, going to the organization of the capital, product, and labor markets, the ephemeral nature of intellectual property, and the disruptive nature of innovation. Incentives in the compensation of both executives and money managers play a role. None of this is easily fixed.
The move to semi-annual reporting would be a small symbolic political victory for the disparate forces that want to shift the norms in our economy back toward old-style corporatism and away from obsession with share prices, shareholder primacy, and shareholder rights. Some of that campaign is well-meaning. Some of it part of a rent-seeking strategy by executives to win back more managerial autonomy and the private benefits of control. Given the inevitability of the latter, carefully thinking about the balance of costs and benefits is wise with respect to deregulatory proposals like this, not just new regulation. I doubt that this idea passes the test.
This post comes to us from Donald C. Langevoort, the Thomas Aquinas Reynolds Professor of Law at Georgetown University Law Center.