Should CEOs of Public Companies Offer Earnings Guidance?
A small but growing chorus of public company CEOs is deciding not to provide quarterly earnings guidance. Is this a good or bad development for shareholders, investors, analysts, the marketplace, and the company’s short- and long-term health?
Based on some of the most thoughtful comments to any of these columns, one might conclude that acceptable earnings guidance by CEOs should take on new forms. Let's first consider the pros and cons, then some research, then some recommendations.
Sandi Edgar, citing her former employer's practice of providing detailed information about the company's "quarterly standings, stock prices, new acquisitions, etc.," concludes that "anyone who has stock or investments in a public company should be privileged to certain short-term information. . . . Taking away these privileges will drive investors away to other companies." Guillermo Estefani concurs, saying, "It is important to show all real information available from the company, so investors can track its behavior and learn whether it is really achieving its long-term targets."
Citing his experience, Terry Ott commented, "I worked in a private company that went public. . . . Post-IPO, the company has continued to do well but the morale has seriously declined because employees feel pressure to have the business look good on a quarterly basis." Lola Wilcox put it this way: " . . . vast amounts of internal energy go to 'making the quarter return' rather than serving the customer and building the future. Why did quarter returns develop in the first place?" Bill Hubbell added, "The market has many mechanisms to establish expectations. . . . There is no benefit in risking this exposure."
Shiva Rajgopal, who has investigated firms that stop giving guidance, shared some of his findings and those of his colleagues: " . . . firms that stop guiding have poor trailing earnings and stock return performance; they also have lower institutional ownership. We document an average -3.6 percent three-day return around the announcement to stop guidance. . . . After the elimination of guidance, stock prices lead earnings less, but there is no change in overall stock return volatility or analyst attention. After firms' decisions to stop giving guidance, analyst forecast dispersion increases and forecast accuracy decreases." For those wishing the full story, read "Is Silence Golden? An Empirical Analysis of Firms that Stop Giving Quarterly Earnings Guidance."
What is to be done? A number of suggestions were advanced. Gaurav Goel suggested that, "Providing conservative guidance to the market may ease pressure to squeeze the last cent out of your client's pocket or to push your employees to their limits." Gerald Nanninga wrote, " . . . the issue is what type of guidance one gives. If you give low near-term guidance, . . . the stock does not go up as quickly. . . . But it doesn't go back down as quickly later, either." Damon Leavell takes a different tack, recommending that, "Rather than speculate on earnings, . . . create unique indices based on (the) business that provide a guide to the health and well-being of the company and the industry." And Lorenzo Ferlazzo comments, "I would maybe run a slew of guidance measures in commentary . . . and suggest analysts use their own initiative to communicate their interpretation to the markets."
These comments raise more questions. Can comprehensive retrospective data compensate for projections? What is "real information"? And do conservative estimates of the future lead organizations to underperform? What do you think?
This question is not as innocuous as it might at first seem. According to those who study the matter, it may become part of a larger debate in 2006 about added pressures on managers to produce short-term earnings regardless of the impact on the long-term health of the business.
In his annual year-end letter to directors, Martin Lipton, a long-time student of corporate governance, cites the issue as one of the three most important issues facing managers and directors in 2006. He commented that, "Activist shareholders, led by hedge funds which today have aggregate assets of more than one trillion dollars and armed with the threat of withhold-the-vote campaigns against directors, will exacerbate the tension between short-term performance and long-term success of the corporation . While different in form, this hedge fund pressure raises management and board issues similar to those created by the pressure to give quarterly earnings guidance and then meet the targets."
In a 2002 article in Fortune magazine, Daniel Vasella, CEO of Novartis, weighed in on the guidance issue: "The practice by which CEOs offer guidance about their expected quarterly earnings performance, analysts set 'targets' based on that guidance, and then companies try to meet those targets within the penny is an old one. But in recent years the practice has become so enshrined in the culture of Wall Street that the men and women running public companies often think of little else. They become preoccupied with short-term 'success,' a mindset that can hamper or even destroy long-term performance for shareholders." Perhaps with this in mind, a small but growing number of public company CEOs are electing not to provide earnings guidance, risking reduced interest on the part of analysts and possibly less publicity for their companies.
But this raises several questions. If this is the age of transparency, why shouldn't CEOs provide as much information as possible, including quarterly and annual business projections, in the interest of better information to investors? Isn't this part of the "perfect information" that markets (as opposed to individual investors) are often assumed to possess? On the other hand, haven't European markets and investors functioned just as well without very much forward guidance from management? Aren't diligent analysts able to come up with reasonably accurate projections without the assistance of management? Is it possible that the short-term pressure to meet public targets set by CEOs and analysts is beneficial to long-term performance as well? On balance, how does the practice affect investors? How should CEOs respond?
Is it coincidental that these questions are arising at precisely the time that the Securities and Exchange Commission is advocating disclosure of CEO pay packages, including the value of large stock option grants which many might conclude produce similar pressures for short-term performance? What do you think?