Nix Quarterly Guidance

READERS OF Business Insights over the years may have discerned that I am not a big fan of what is known as short-termism—a company's emphasis on the next quarter's or the current year's projected results rather than on a long-term view of its prospects. More and more, thankfully, business groups and think-tanks are taking a similar view.

In late June, the Committee for Economic Development (CED), a business-led policy group, released a report from its corporate government subcommittee calling for more long-range thinking.

"Decision-making based primarily on short-term considerations damages the ability of public companies—and, therefore, of the U.S. economy—to sustain superior long-term performance," said William Donaldson, who heads the subcommittee. "Emphasis on quarterly earnings, compensation tied to earnings per share, shortened CEO tenures, and financial reports that fail adequately to inform about company performance impede the task of building long-term value." Donaldson should know whereof he speaks, having been chairman of the Securities & Exchange Commission from 2003 to 2005.

The report, "Built to Last: Focusing Corporations on Long-Term Performance," makes a number of recommendations for executives and boards of directors, including the following:

• Support management's development of comprehensive strategic plans with long-term objectives, and assess management's performance via those objectives;
• Link executive compensation to long-term performance;
• Encourage succession planning and address shortened chief executive officer tenure, since shortened tenure for today's CEOs has turned their attention to short-term results;
• Develop more meaningful indicators of corporate value by encouraging managers to adopt reporting systems that focus on "value drivers" and long-term risks;
• And, finally, urge company leaders to voluntarily refrain from issuing short-term guidance.

It is this last point that is getting attention from business groups, including last year from the Business Roundtable and the CFA Institute, and more recently from the U.S. Chamber of Commerce and the Aspen Institute, a policy think tank.

According to the CED report, the practice of providing earnings guidance grew out of reforms in the early 1990s intended to provide greater transparency and allow companies to issue forward-looking statements. The role of earnings guidance "is to communicate and establish expectations about company performance," CED says. "Unfortunately, those expectations are focused on partial, short-term results. ... Managers are driven to put the goal of meeting the guidance above other, longer-term goals."

The report puts in a real kicker: "In some cases, managers have made decisions, based in part on the perceived need to meet earnings guidance, that have had materially adverse effects on the company. In the case of Enron, such decisions effectively destroyed the company."

The cost of management time and other resources devoted to providing guidance is significant, the report says. It notes an article in the March 9, 2006, issue of the Economist that cited quarterly earnings guidance and its pressures on companies as one of the reasons that executives agree to private equity buyouts.

CED does not call for an end to all quarterly guidance. "Short-term performance may be particularly important to analyses of newer companies with little operating experience," it says.

Not all groups are this lenient. A group of CEOs, business organizations, institutional investors, labor unions, corporate lawyers, and accountants organized by the Aspen Institute recently developed what has come to be called "The Aspen Principles." At the top of the list of these principles is a call for "companies to stop providing quarterly earnings guidance to analysts, and to not respond to analyst estimates."

One has to wonder how effective quarterly guidance really is. Thomson Financial collects individual company earnings forecasts made by security analysts and develops what is called a consensus forecast. Corporate performance is judged by many company watchers on whether a company "beats" this forecast or not.

Thomson conducted a study of Standard & Poor's 500 companies and found that the firms that provided earnings guidance beat the consensus forecast 65% of the time, while companies that didn't provide guidance bettered the estimate 63% of the time. Is the difference significant? Probably not, so why bother?

Not all companies issue earnings guidance. Among the U.S. chemical makers followed by C&EN, there are a number, including Hercules and industry leader Dow Chemical, that do not. On the other hand, a number of them do. Number two DuPont doesn't exactly give quarterly guidance but rather earnings-per-share guidance for the full year, which is updated each quarter.

There are voices on both sides of the issue. My personal feeling can be summed up in a rhetorical question. Every day, we, as individuals, are told to "invest our money for the long term." So why do corporations seem to feel that the most important information they can give to stockholders is what earnings per share will be at the end of the next quarter or the end of the year?