In December 2018, the SEC posted a “request for comment soliciting input on the nature, content, and timing of earnings releases and quarterly reports made by reporting companies.” According to the press release, the request for comment solicits “public input on how the Commission can reduce burdens on reporting companies associated with quarterly reporting while maintaining, and in some cases enhancing, disclosure effectiveness and investor protections. In addition, the Commission is seeking comment on how the existing periodic reporting system, earnings releases, and earnings guidance, alone or in combination with other factors, may foster an overly short-term focus by managers and other market participants.” (See this PubCo post.) At the end of March, the influential Council of Institutional Investors submitted its comments in response to the SEC request.
In its comment letter, CII defends the current quarterly reporting system, viewing quarterly reporting as a “key element of the timely and accurate information flow that underpins the quality and efficiency of our capital markets. The requirement helps ensure that important information is promptly and transparently provided to the marketplace, allowing investors to assess concrete progress against strategic goals.” More specifically, CII contends that the requirements of quarterly reporting “foster discipline and accountability,” including the independent auditor review, management certifications, “filed” (as opposed to “furnished”) status and XBRL data tagging. For example, with regard to auditor review, CII maintains that the review increases public confidence in the financial information because it is believed to “increase the quality, usefulness and reliability” of the financial statements.
With regard to a potential shift to semi-annual reporting, CII believes that “less frequent reporting would likely lead to greater share price volatility, and more intense investor focus on short-term share price fluctuations, as investors expend more effort guessing how the company is doing.” In support of that contention, CII cites an academic study showing that ‘a reduced frequency of reporting may lead investors to overreact to alternative sources of information for non-reporting periods.”
Nor does CII believe that quarterly reporting contributes to short-termism: the “notion that quarterly reporting encourages short-term thinking is in our view outdated and generally not supported by empirical evidence.” Rather, CII contends, less frequent reporting “will lead to greater stock price volatility, as investors do more guess-work on what is happening at a company, increasing the potential for short-term profits and thereby intensifying short-termism. Less timely information and greater stock price volatility also would invite more insider trading, which CII believes undermines confidence in the market.” Moreover, CII argues, “the view that three months is ‘short-term,’ but six months is ‘long-term,’ seems highly questionable at best.”
In addition, CII recommends that the SEC address the timing of quarterly reports and earnings releases, advocating that quarterly reports be issued before earnings releases and earnings calls to allow investors “time to review GAAP financials before being inundated with non-GAAP information.” Alternatively, CII would support concurrent release in a comprehensive package.
To encourage long-term thinking, CII argues, rather than decreasing the frequency of periodic reporting, the SEC should instead focus on discouraging quarterly forecasted earnings guidance, which CII believes is a “much more significant contributor” to short-termism. Earnings guidance, is, “by definition” “predictive and speculative,” and “can have negative effects on investors, companies and capital markets.” First, CII suggests that the SEC require all earnings guidance to be “furnished” to the SEC. More significantly, because CII advocates that companies focus on long-term growth and sustainability, it generally supports the decision to decline to provide quarterly earnings guidance altogether. Again, CII believes that “guidance can cause undue focus on short-term profits at the expense of long-term strategy and investment. More specifically, we believe quarterly earnings guidance can incentivize companies to unduly focus on ‘making the numbers’ at the expense of the long-term interests of the company and its long-term shareowners.”