Too Much Information? Investors and corporations could benefit from less frequent financial reporting.

• Author: Brannon, Ike
• Position: SECURITIES & EXCHANGE

The Securities and Exchange Commission requires public companies to report their earnings and a variety of other financial statistics every three months. The requirement is intended to provide investors with timely data to help them make informed investment decisions.

Financial economists have long questioned the practice, wondering if it really does serve the interests of investors. There are reasons to think it does not. For starters, producing earnings data often is costly both to investors and the firms, and it is unclear whether the incremental value of the second, third, or fourth earnings report in a year is worth the incremental cost of producing it.

Second, there is evidence that providing earnings data every three months may be counterproductive. Such frequent reporting may engender a myopia among managers, encouraging them to focus on achieving quarterly profit targets to the detriment of long-run profits.

Third, the frequent reporting of earnings may create noisier data. Isolated events that significantly affect profits in one quarter may cause investors to overreact. The complementary fear is that companies may take steps to "smooth" these ephemeral fluctuations, either via accounting gimmicks (thereby rendering the data less relevant) or by making real changes to the company's operations that potentially reduce long-term profits.

Finally, the quarterly reporting of earnings data may crowd out the release of ancillary, relevant information. In a world where managers want to keep investors fully informed of their companies' fiscal health, trading off the frequent and voluntary provision of relevant data for mandatory (and costly) quarterly reporting may not be in investors' best interests.

The effect of frequent reporting periods can manifest in various ways. For instance, the strictures that quarterly reporting places on the management of public companies are one reason why start-up companies and their investors have been content to eschew initial public offerings (IPOs) and remain privately held for a longer period than was the case in the 1980s or 1990s. The 10 years Uber spent as a "unicorn"--a highly valued, privately held firm--can be attributed in part to the desire to avoid the additional costs of quarterly reporting.

The costs of being a public corporation have gone up in the last two decades. The Sarbanes-Oxley Act significantly increased reporting costs for public corporations, reducing new IPOs. The 2010 Dodd-Frank Act includes several expensive rules, including "conflict mineral" reporting and chief executive officer compensation disclosure. (See "The Meaningless of the SEC Pay Disclosure Rule," Spring 2014.) These requirements help to explain why the ratio of private IPOs (that is, non-public capital fundraisings) to public IPOs has increased significantly since 2000.

The SEC recently indicated that it would study whether to reduce earnings reporting to semi-annual or even annual events. Reporting frequency differs between Europe and North America and has also changed various times in the United States since the 1950s, providing data with which to study the issue. The research suggests that a reduction in reporting periods is well worth considering.

REPORTING FREQUENCY MAY ABET MANAGERIAL MYOPIA

The most common criticism of quarterly reporting is that it leads to managerial "short-termism" whereby firms place an excessive emphasis on achieving short-run earnings goals at the expense of long-run growth. A firm preoccupied with satisfying financial markets every three months may be tempted to reduce productive long-term investments elsewhere--such as research and development--to hit its quarterly numbers.

Blackrock chairman and CEO Larry Fink and former PepsiCo CEO Indra Nooyi advocate releasing earnings every six months, while JP Morgan CEO Jamie Dimon and Berkshire Hathaway CEO Warren Buffett, eminences grises of the investment world, have suggested that ending quarterly earnings guidance would be a good first step toward reducing the short-term thinking that too often occurs in the boardroom.

Arguably the most successful public corporation of the 1990s, General Electric was famous for exceeding analysts' expectations by a penny a share each quarter for years at a time. That was one of the reasons it became the most valuable company in the world. However, its obsession with attaining positive quarterly earnings surprises ultimately hurt shareholders as the firm devoted much more effort to accounting chicanery than to producing long-term growth. In the 1990s, it typically used carefully timed capital gains and restructuring charges...