Summing Up
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?
Original Article
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?
In reality the high goals for offering guidance have disintegrated into lazy analysts just regurgitating management forecasts, than whining on earnings conference calls when any variance, positive or negative, occurs from said guidance. In the world of unintended consequences, time is wasted discussing the forecasting rather than the underlying business.
Go back to the way it used to be. If people want to follow Novartis, as mentioned in Jim Heskett's article, then go to doctors' offices and find out what is being prescribed.
Does guidance mean CEOs have a crystal ball that can predict the future? Indeed we need guidance, but it should be based on initiatives for long-term growth plans, not just numbers.
I have seen company behavior change as it deals with pressure to meet the guidance (e.g., employees work on weekends to meet the quarterly results, spend more energy getting the numbers right rather than thinking about how to create a culture of innovation, and so on).
Companies should build mechanisms to get realistic guidance from different units in real time, and in the name of transparency the CEO should provide the earnings guidance to shareholders and employees.
The CEO (along with the unit heads and top management) has to perform a balancing act between stable, long-term growth and quick, short-term gains. The short-term tactics to meet the guidance should be aligned to the long-term strategy.
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. The market needs to appreciate that there's less risk with the companies and individuals who have a long-term strategy and growth plan.
I think CEOs should provide guidance. It is in keeping with the principles of transparency that are being drilled down from agencies like the Securities and Exchange Commission and the Financial Accounting Standards Board. Without them, stakeholders such as investors have little direction in making their decisions regarding a company stock purchase.
While working for the largest gourmet coffee establishment in North America, Starbucks, we were continuously updated with our company's quarterly standings, stock prices, new acquisitions, etc. The CEOs, presidents, and managers did not own the company, we did. I believe anyone who has stock or investments in a public company should be privileged to certain short-term information. With the degree of fluctuation in which our economy operates, it is imperative that investors know where their money is going as well as the current return rate. Once satisfied with this information, one would hope the investors would not merely sell their shares based on a short-term analysis.
Comparing ourselves to the European business model is not reasonable. We have established trust with our investors because of the degree of certainty we give them; they know where their money stands as well as what it is worth. Taking away these privileges will drive investors away to other companies.
I think that establishing a short-term carrot is not a very wise way to develop businesses. Nevertheless, I consider that 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. There will be more risk in "the rules" if a company decides to establish a long-term objective.
My coauthors and I have investigated firms that stop giving guidance. Consistent with many of your statements, we find that 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; this reaction is associated with poor future performance. 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.
You can access our paper, "Is Silence Golden? An Empirical Analysis of Firms that Stop Giving Quarterly Earnings Guidance," at: http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=820644
I think CEOs should not give earnings guidance. I worked in a private company that went public. In the private environment, the company thrived and the morale was high because management took the longer-term view; employees knew that the partners would value innovative and somewhat risky ideas because the emphasis was always on doing the right thing for customers, knowing that down the road the financial side would take care of itself if the ensuing decisions were wise. We talked about how we did financially after the fact, and seriously, but only annually.
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. Costs are much more scrutinized and micromanaged based on how they will affect quarterly earnings. Of course, much of this just comes with the territory of being public. But the stakes are raised, and along with that so are tensions and the propensity for shortsightedness, when the executive team's reputation is on the line by virtue of some educated guesses about near-term earnings. It seems to me that stock price volatility is very much tied to the earnings forecast and results. A penny or two in either direction from the quarterly forecast is viewed as significant when, by the very nature of this professional services and "lumpy revenue streams" kind of business, the best we could ever hope for would be round number guesstimates of earnings, even in the medium term.
I'd rather have the CEO take the same position of the NFL coach who refuses to venture a guess about the team's season-end record, and who won't say whether or not a victory is likely versus the teams he is facing in the next month. It is enough to comment on the actions and priorities being taken to ensure the team has its very best chance of success.
So . . . let's be done with the game playing and manipulation. Just let the record speak for itself.
As a consultant to large organizations responsible for helping them forward, I have seen top management drive to quarter returns rather than invest in the long range. Further, 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? Was it an oversight mechanism to warn investors of an issue in the first three months? It takes three months to notice an issue and correct course. The size of the organizations we are watching today makes a major change a three-year process. But we are moving CEOs every one and a half to three years. The entire mechanism needs to slow down if we are going to invest in the future.
Companies should refrain from giving guidance on expected future results, whether revenues or earnings. The market has many mechanisms to establish expectations. CEOs face an ever present risk of being wrong about the future. There is no benefit in risking this exposure.
Certainly CEOs must have a business plan with a projection of what they would like to see the corporation achieve . . . or maybe it's their own salaries and stock options. I certainly don't think it's important to announce what those plans are any more than a football team telling the public they are going to win. It's all a crapshoot. The investors certainly want a return on their investment, but they are not going to know that ahead of time anyway.
The biggest schism between CEOs and investors is their salaries, stock options, and other perks that are not tied to performance, money that might contribute to the bottom line if it were.
An entertaining question!
If I were a smart CEO thinking of how I could capture publicity without restricting guidance and alienating institutional investors, I would maybe run a slew of guidance measures in commentary (maybe five or six, including earnings per share), emphasize the preferred ratio/measure, and suggest analysts use their own initiative to communicate their interpretations to the markets.
Gee, what have I just done? Well, (1) I've given earnings per share, so that keeps Wall Street happy, (2) I've given more than earnings per share so that makes me even more transparent and makes everyone happy, and (3) I've indicated the choice of short-term metric and that makes everyone think a little more. And I could even go so far as saying that I've transparently informed the market without really giving away too much.
For a quarterback who enjoys playing laterals to running backs, this makes sense. Advancing with caution and a range of options extends the offense and keeps the defense thinking right up to the line!
Guidance has created more problems than it has solved. The quest for short-term profits has put a damper on many long-term projects that would help companies compete or even survive in the future.
Situations change on a constant basis. Guidance is just another form of guessing what will occur in the future. Strong profitable companies cannot be built on guessing unless you're in the gaming business.
The more guidance is emphasized, the more we will experience shortsighted decisions and self-fulfilling prophecies. The tenure of CEOs has fallen drastically in recent years. I feel some of the cause is due to this "guidance" and the failure to live up to these guesses and forecasts.
How often is the guidance correct? Business articles and programs seem to point to the fact that guidance is often not correct. No one knows the future, including CEOs. Let's not bet the bank on their educated guesses.
The reason to keep away from only a short-term focus is to prevent premature liquidation of a company. Two decision errors tend to lead towards premature liquidation: (1) underinvesting in the core business because the payback is not immediate, and (2) divesting of assets today for a quick profit, even though they may provide the competencies needed to get to a more prosperous long-term future.
So the question is whether a lack of guidance will help avoid these two errors. In general, I would think that whether one gives guidance or not has little bearing on these errors (unless one makes promises in the guidance that can only be fulfilled through premature liquidation). Instead, the issue is what type of guidance one gives. If you give low near-term guidance, because you do not want to prematurely liquidate the company by taking excess profits too early, that sends a specific message to the market.
Granted, the stock does not go up as quickly this way. But it doesn't go back down as quickly later, either.
Two things need to occur:
1. Get the profile of the people who desire to invest in your stock to be the type of people who invest for the long term. This can be done by sending the right kind of market signals and courting the right kind of investors.
2. Compensate top executives for long-term performance.
I think the bigger problem we have is that the average tenure for a CEO at large public companies is too short. They disappear before the long-term ramifications of their actions take place. They need to be compensated in such a way that the long-term ramifications beyond their tenure are a meaningful percentage of their total compensation.
While I understand the importance of providing a constant flow of company information, I don't think it's a good idea to provide quarterly earnings estimates. I would argue that estimated earnings do not amount to transparency; on the contrary, they muddy the issue. Rather than speculate on earnings, provide investors with more information about the company or offer expanded financial data. One thing companies could do is create unique indices based on their business that provide a guide to the health and well-being of the company and the industry. Especially for sector leaders, this could be a great way to maintain analyst and media attention while continuing to solidify their brand in the marketplace. To circle back, earnings guidance is a form of speculation. Whether or not a company hits a quarterly estimate should not be a determining guide for investors.
I think providing short-term guidance can produce a lot of pressure to meet the numbers, leading to extraordinary actions that are not representative of the company's usual business and/or accounting practices.
Quarterly measures by themselves do nothing more than stoke up short-termism. However, presenting them within the context of a well defined, longer-term strategy is helpful in pointing out whether an enterprise is on course. But nothing in life is certain and perhaps the quarterly statements should be more concerned with articulating variance. That way leaders would plan more diligently and conceptualize both the upside and downside possibilities. An organization should be managed with a mind to have a longer life than a fly!