Sucheta Dalal :Tyranny Of Quarterly Results (28 July 2003)
Sucheta Dalal

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Tyranny Of Quarterly Results (28 July 2003)  

What started out as little murmurs about the exaggerated expectations from Corporate Governance Codes is slowly growing into a muted global debate. Ethics, like democracy, is easier in theory than in practice cannot be mandated.

The murmurs against good behaviour being reduced to a set of rules, are not necessarily coming from shady companies wanting to scuttle the codes with their specific prescriptions about everything from management structure, to audit committees and appointment of trained directors. They are people who are sceptical about whether endless disclosures and the presence of independent directors on boards can force shady company management to turn ethical. Or, whether a bunch of outsiders, notably independent directors, can really take on the onerous responsibilities that have been foisted on them.

The answer to these questions is likely to be vague or evangelist. In an article “How deep is the ethics crisis” Stewart Pinkerton of Forbes says: “Forget Sarbanes-Oxley. You can’t legislate ethics”. Many organisations like the Social Investment Forum of America, who would disagree. They argue that the score or more Corporate Governance Codes is just the beginning...what they want is the “next wave of reform” and more rules to stop companies from straying into unethical behaviour.

Others like GN Bajpai, chairman of SEBI are not hung up about the rules, but argue “Corporate governance has a reason...we can’t possibly eliminate it. Just like in the governance of a state, we need to know how the work is being done”.

But experts and fund managers wonder whether good-governance codes, reduced to a checklist of dos, don’ts and disclosures are really improving corporate ethics, enhancing shareholder value or providing more information to shareholders. If the answer is no, then the checklist needs closer examination. It would appear that the biggest irritants for the corporate world are, ‘quarterly results’ and ‘earnings guidance’. While quarterly results are mandatory in India, the rest of the world is adopting the practice only gradually. Moreover, providing earnings guidance is often a matter of choice overseas.

Some corporate governance pundits believe that if management communicates its strategies and financial condition properly and is sincerely interested in building the business over the long run, then quarterly financial statements do give investors a useful way to track performance against those strategies. This group argues that there’s no reason why earnings announcements, particularly if they are preceded by honest guidance, should cause undue volatility in trading or be unduly distracting to top executives.

Ironically, it’s companies with high ethical standards that are chafing at the “tyranny” of quarterly results and guidance; others go their merry way and throw a few numbers at investors and analysts, knowing that the books can always be adjusted to meet targets.

Forbes (in the same article) quotes John Bogle, founder of the Vanguard Group and described as a person with “exemplary ethical credentials” as saying that he’d like to fix the investment system by eliminating quarterly “earnings guidance”.

At a recent discussion in Mumbai on whether sustainable value creation was possible, Cyrus Guzder, CMD of AFL Ltd and also a person of exemplary ethical credentials said that the “tyranny of quarterly results” may be a deterrent enough for companies like his from seeking a stock market listing (AFL is not a listed company).

The stock market’s negative reaction to the quarterly guidance of Infosys Technologies in the last quarter is an example of how awry an honest guidance can go. Infosys’ projections caused such an avalanche of selling by FIIs that the company was blamed for destabilising the market. In the immediate next quarter, Infosys itself is more positive and its results and forecast sent the scrip into a bullish frenzy.

No wonder then that at the elite Davos summit of the world’s movers and shakers saw the heads of Goldman Sachs and Deutsche Bank reportedly touting the idea that companies should drop reporting quarterly results and move only to annual earnings disclosures. The chief of Caisse de depot, Canada’s largest institutional investor, reportedly endorsed the idea.

The argument against quarterly results and earnings’ guidance is usually that it tends to force companies to manage market expectations on a quarterly basis and monopolises management time, which ought to be spent on running the company. Those ranged against quarterly guidance also argue that it makes investors myopic by focussing them on the extreme short term. The plethora of earnings forecasts from investment analysts –– often wrong –– also underline the excessive focus on the short-term prospects rather than the long-term performance of companies.

It is worth noting that Coca-Cola, Gillette and The Washington Post Company, that have the legendary Warren Buffet as their director, all refuse to provide earnings guidance. When Coke decided to stop providing quarterly earnings guidance, there were many who cheered its decision as a move towards more corporate honesty and an elimination of the temptation to jigger performance numbers.

Are we then arguing that investors would really be better off having less information in the short term? Not really. Only that, the quality of information is far more significant than its frequency. And that very little can be achieved through mandatory rules. Companies that don’t want to divulge accurate information will always find a way to ‘manage’ both earnings and forecasts. Having said that, it’s a little premature to advocate a relaxation of corporate governance rules and/or to eliminate the ‘tyranny’ of quarterly results and forecasts. Although many companies will indeed comply with governance codes only in form rather than substance, the best course would be to moderate our expectations from the codes and give ourselves adequate time to build up empirical evidence that would help decide the issue one way or another. Until then, it has to be treated as a necessary evil. In fact, we would do well to go with what Cyrus Guzder has to say (rephrasing of Winston Churchill’s famous comment about democracy): “Let me say this about corporate governance; it is a terrible thing, but all the alternatives are worse”.

-- Sucheta Dalal