By Douglas A. Stuart, University of Victoria, The Conversation
United States President Donald Trump is, once again, suggesting eliminating quarterly reporting for American public companies in favour of just two earnings reports per year. Trump made a similar proposal during his first presidential term in 2018.
Quarterly reporting is the practice by which publicly traded companies provide financial updates every three months. These reports are meant to give investors, regulators and other stakeholders information about a company’s financial performance.
In a social media post, Trump said such a move “will save money and allow managers to focus on properly running their companies.”
The U.S. Securities and Exchange Commission (SEC) is prioritizing Trump’s proposal. The SEC studied the issue in 2018 and held a roundtable but did not move forward with rule changes.
Canadian public companies also report quarterly, while other markets, including the European Union, have adopted a six-month reporting model.
Researchers have studied reporting frequency for decades, and the scientific evidence shows the thinking behind eliminating quarterly reports is not cut-and-dried.
Quarterly reporting as a monitoring tool
Quarterly reporting is expensive. Employees’ time, executive review, board oversight and investment in reporting systems add up. Cutting external quarterly reporting could free up a company’s internal resources and remove administrative red tape.
Even so, some companies report every three months without being required to. Preparation costs increase, but so does corporate accountability. In terms of agency theory, shareholders (the principals) can more closely monitor the behaviour of executives (the agents).
Executives are expected to represent shareholders, but their priorities do not always align. Corporate executives may, for example, reject profitable investments due to their risk tolerance or overspend on travel and leisure items.
With quarterly reporting gone, the potential for these “agency costs” may increase as misaligned managerial actions go unnoticed. Shareholders use accounting reports to check up on executive decisions and hold them accountable.
Importantly, even if semiannual reporting becomes the baseline for public companies, banks may still ask for more frequent results in loan agreements.
Quarterly reporting for investment decisions
If regulators drop quarterly reporting, investors and the public could lose out.
Many investors have a limited sense of how a business is performing. They may live half a globe away and never set foot in the company’s offices. Because of this, investors generally have access to less information than internal employees, managers and executives do. This is called “information asymmetry.”
Investors, regulators and the public depend on corporate financial reporting to fill in these information gaps. If quarterly reporting mandates were removed, they might be left in the dark. Investment decisions might be less informed, although news releases and disclosures online could still be found. Corporate transparency and accountability might be reduced.
On the other hand, quarterly reporting is not a cure-all. Analysts might under-react to earnings reports, leading to delays. Or they may overreact, causing unwarranted fluctuations in investment prices. Investors are human and are subject to shortcomings like overconfidence and the fear of missing out.
Short-term versus long-term decisions
While quarterly reporting can be seen as a compliance activity, like filing taxes or acquiring a business licence, it can also be framed as a structure for decision-making.
Quarterly reporting incentivizes executives to focus on short-term financial performance, potentially at the expense of long-term results. Researchers call this “short-termism.”
Researchers have found that short-termism is not limited to managers and might stem from investors looking for quick profits. Investors may, directly or indirectly, influence the kinds of projects managers invest in. Managers may get financial bonuses based on quarterly earnings to align their goals with shareholder aims.
Short-term decisions are frequently tactical rather than strategic, meaning they may prioritize current earnings over long-term corporate sustainability and resilience.
For example, managers might invest in carbon-intensive projects that pay back quickly, rejecting more sustainable projects with a longer return horizon, like energy efficiency. For this reason, some sustainability advocates support Trump’s initiative.
While some firms measure their performance along social and environmental lines, in addition to financial earnings, profits are often the focus of quarterly earnings calls.
Not one-size-fits-all
Quarterly reporting may affect small and large firms differently. Smaller firms may take a financial hit: on average, small firms in Singapore experienced a five per cent drop in market value when they were required to report quarterly in 2003.
However, larger firms may find that the benefits of prompt, high-quality information outweigh the costs of frequent reporting. Managers, executives and board members rely on accounting reports to show whether the firm is on track to meet its goals.
Furthermore, larger firms document industry conditions and future risks and opportunities in their accounting reports. Smaller firms in the same industry can look at this information for guidance. These are called “positive information spillovers.” Smaller firms may lose this information if larger firms file reports less often.
Information spillovers, however, can be a double-edged sword. Information may be taken out of context or applied to smaller firms incorrectly. At times, this may lead to temporarily poorly priced investments.
Treading carefully
We don’t know, yet, what the SEC will decide. If changes are to come, they should be made carefully and phased in. Pilot studies would give policymakers and researchers a chance to observe effects in real time.
Quarterly reporting mandates on the Vienna Stock Exchange were phased out between 2015 and 2019. Some companies continued to file quarterly financial results while others stopped. Firms used the increased flexibility to adjust the content of their reports, making them more relevant to their stakeholders.
Research shows corporate reporting frequency is a complicated topic. Switching from quarterly to semiannual reporting may have merit, but as with any decision affecting a wide range of stakeholders, a broader, global perspective highlights what some stand to lose and what others stand to gain.
Douglas A. Stuart, Assistant Teaching Professor of Accounting, Gustavson School of Business, University of Victoria
This article is republished from The Conversation under a Creative Commons license. Read the original article.
