Recent analysis shows that the majority of FTSE 250 organisations no longer submit quarterly reports. Is this a sign of increasing focus on long-term planning or simply the avoidance of an ultimately pointless exercise and administrative burden?
There have been numerous articles, reports and commentaries on this topic, often focusing mainly on the external market perception or reaction. I believe however that we need to look deeper and focus much more on how these requirements, in force between 2007 and 2015, affected not just results, but culture.
They are familiar headlines to all of us – ‘Company X sees record quarterly growth’ or ‘Company Y sees quarterly profits plunge’, swiftly followed by numerous opinion pieces outlining why things are going right or wrong. Is the decline in reporting every three months a wise move though? The FCA certainly thinks so, moving to drop the requirement in 2015, albeit somewhat quietly, after a consultation period.
The response to whether the requirement should be dropped was broadly positive, but will it really relieve pressure on businesses and ultimately help to solve the UK’s productivity conundrum? Many are doubtful to say the least.
Several reports have highlighted the fact that the introduction of mandatory reporting in 2007 led to no material impact on investment decisions that companies were making. There was also a marked shift toward qualitative reporting and, to use Mark Carney’s somewhat infamous phrase, ‘forward guidance’ on annual performance.
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Whilst the argument that the external impact has been negligible can be persuasive, there are many senior finance professionals who believe that the biggest impact of quarterly reporting requirements has been internal and not necessarily positive. Many believe that pressure on CFOs and FDs to hit short-term targets has resulted in poor decision-making processes that damage not just a company’s image, but also the company’s culture.
The Economist John Kay, in his government commissioned 2012 review, stated that ‘hyperactive behaviour’ by executives focusing on short-term objectives was proving increasingly costly to organisations in other ways. And it wasn’t proving costly just in relation to individual businesses; some were arguing that it produced economic drag that ultimately affects the entire economy.
Eliminating the need for regular and rigid reporting structures has led to a marked decline in companies choosing to report quarterly. In early September the Investment Association report revealed that 40 per cent of FTSE 100 companies and 60 per cent of FTSE 250 companies no longer produce quarterly reports for shareholders.
Is it all good news though? The leading and clearest argument for quarterly reporting is the transparency it provides us. Investors, rightly, want information and let’s face it – we all now live in a world where information is always plentiful, available and at your fingertips. If we can predict the weather by the hour, track a trans-Atlantic flight on our phones and send satellites to Saturn, why shouldn’t we expect real-time information on company performance?
Quarterly reports have historically played a big part in allowing investors and analysts to gauge the financial health of a company and determine whether it’s worth investing in. So, it’s no real surprise that some argue resolutely against their removal. The elimination of quarterly reports could mean less informed investment decisions and in the worst case, allow companies to bury bad news.
Similarly, quarterly reporting sometimes enables shareholders to spot trends and anomalies early enough to enhance internal controls. Their frequency can also be used to declare dividends at the end of each interim period, and since annual balance sheets these days have lower reserves and more debt, the cash flow depicted by quarterly reports can be extremely important.
Others argue that allowing companies the option to report less frequently enables them to be more selective about the information they choose to disclose to the market, making way for greater scope for earnings management and abuse of accounting.
On the flip side however, a culture of short-termism is fueling the argument against quarterly reporting. Short-termism is reportedly a large factor in the UK’s poor productivity performance and it is well publicised that the UK trails other major markets including Germany, France, and the United States. While many factors have been blamed such as zero-hours contracts and poor management, the Investment Association argues short-termism is a big part of the problem.
According to John Hunter, Chairman of the UK Shareholder’s Association, “quarterly reports are damaging in that they encourage a short-term focus, add to the already over-burdensome corporate reporting requirements and further divert corporate management towards managing investors' expectations instead of managing their businesses.”
In March 2016 the trade body’s ‘Productivity Action Plan,’ was launched with a strong focus on promoting UK productivity. It aims to “boost UK productivity through long-term investment and enhanced investor stewardship."
All well and good many will say, but increasingly finance leaders talk to me about culture. A number of recent scandals have brought this issue to the forefront.
Earlier this year Bovis Homes, one of Britain’s biggest builders, were forced to pay out £7m to repair poorly constructed buildings after pressuring buyers to move into unfinished homes so they could hit aggressive sales targets.
Not only did the scandal leave investors frustrated, the company’s reputation in the eyes of customers took a hammering. Tesco, Carillion and Mitie (to name but a few!) have all hit the headlines in the last several years for all the wrong reasons and a recurring theme seems to be pressure-induced decision-making that leads to long-term problems rather than growth.
That said, there are many finance leaders who are believers when it comes to quarterly reporting. One senior Finance Director I recently met compared the performance of his business to running a long-distance race with a target-time as the goal. In his view, anyone running such a race would need way points or markers to target themselves against and it was no different for him.
Quarterly goals kept the business sharp, focused and allowed him and the board to use real-time information to make decisions (or decide what to monitor over a longer-term basis) in a fast-moving market. Sometimes you’re on track, sometimes you need to speed up and make quick decisions for the good of the business.
Gary McGrath, CFO of FTSE-listed company Zotefoams, disagrees however and is strongly against the whole concept of quarterly reports. He believes that “short-term or quarterly reporting is the antithesis of sound and stable long-term growth, clouding a leadership team’s judgement and putting undue pressure on individuals when they should be focusing on what’s best for the business, even if in the short-term it is costly.”
Gary has spent his career in large, multi-national businesses and notes that the best environments (and most profitable) that he has worked in are those that maintain a laser-like focus on long-term value creation. Zotefoams recently posted an annual profit increase of 25%, so the long-term philosophy they have adopted is clearly working for them!
What about shareholders? Revolts over executive pay plans are clearly nothing new. But there is a growing discomfort around business leaders being financially rewarded on achievement of short-term goals. More and more businesses are exploring retrospective action against executives to claw back bonuses for what proves to be, in hindsight, poorly executed short-term decisions.
Could it be that we move towards a system where bonuses only come good if the impact is seen over a longer period? Perhaps, but hindsight is impossible to apply whilst making real-time decisions and business leaders still need to feel empowered to take risks. That said, the culture in such business environments must be strong in terms of not just visibility, but accountability.
Could this lead to a more volatile stock market? Quarterly reports provide a glimpse on how stocks will be valued in the future, with stock prices rising when earnings exceed market expectations and falling when they don’t.
So, what will the absence of quarterly reports mean for stock prices? Little research has been done into this yet, but it will be interesting to see how the stock prices of the likes of Centrica and Aviva are impacted following their decision to stop providing quarterly reports.
And so we arrive back at the headline of this article. Is the decline in quarterly reporting good or bad? In my view an increased focus on the medium to long-term is no bad thing. Anyone with a pension will no doubt agree that it is long-term market performance that matters!
We should however, be very careful about assuming a lack of long-term thinking or planning in businesses that report quarterly results.CEO’s and leadership teams are, mostly, very much focused on growth and in the current economic climate that can be difficult to achieve in the short-term.
It is the effect on middle/senior management that needs to be carefully monitored by businesses, shareholders and, where appropriate, non-exec board members.
I meet experienced finance and business leaders all the time and their views are often nuanced when it comes to enabling and driving business growth. One size clearly doesn’t fit all when it comes to how businesses grow and deliver long-term value. They tend to be much clearer when it comes to views on how these goals pass down or through an organisation, for it is here where the problems often occur.
Aggressive, short-term targets can sometimes be amplified as middle or senior level managers chase short-term goals, incentives or bonuses. Keeping sight of the long-term goals is critical to getting the balance right and strong, and accountable leaders play a critical role in this. The wins if businesses get this right are obvious and relieving short-term pressures on corporations shouldn’t be a bad thing.
Taking a risk isn’t bad, but the focus has to be on more than instant gratification. If we are to fully eliminate the culture of short-termism, it must be underpinned by strong corporate governance and a board removed from short term pressure, allowing a greater focus on longer-term goals. Sounds simple, right...?