Earnings Confessions: What Disclosures Do Investors Prefer?
Modern life requires us to process an ever increasing load of information. Whether its email, Twitter, LinkedIn, WhatsApp, Facebook, WeChat, etc., there’s an array of data channels that demand our informed participation. For those in the financial markets, earnings seasons turn that daily data deluge into a full-on tidal wave.
Research studies confirm that earnings account for a relatively low 1.5%–2% of total new information content about share prices in terms of the value add. Yet, four times a year quarterly earnings force asset managers into a regular crystal ball–gazing competition. They strive for relative return and incentivize companies to follow suit. Companies, the research demonstrates, thus focus more on “bettering” their quarterlies at the expense, arguably, of longer term business decisions.
In the United Kingdom, regulators believe that quarterly reporting has significant downsides. Wary of markets running around in counterproductive short-term circles, regulators there recently made quarterly reporting optional. Their counterparts in other countries may adopt similar measures.
The criticisms of data overload, of short-term, myopic “crossing the road” thinking over a more nuanced, “navigating the journey” approach are all valid. But it is not the full picture. Increased disclosures came into effect in the first place to avoid information asymmetries, to prevent companies from operating under dark clouds with no transparency. The disadvantages of mandatory interim quarterly reporting, therefore, have to be carefully weighed against the value add that such disclosures can bring.
To understand investor opinion, we administered a survey to readers of CFA Institute Financial NewsBrief to gauge what sort of earnings disclosure had the most importance for their investment decisions. Here’s what our 471 respondents told us:
Which of the following earnings-disclosure events is the most important for investors?
All Quarterly Earnings Periods Are Important: 53%
A relatively large majority of respondents said that quarterly earnings reports are the most important. After taking the other responses into account, however, the overall preference for more disclosures stood at an overwhelming 98%. This is an interesting and emphatic statement that reflects a desire for more information not less, despite the recent steps taken by UK regulators. This could be driven by information asymmetries created by the company, industry, or country. Supporters of the efficient markets hypothesis, too, would naturally demand more data and would look to arbitrage any apparent information edge others might have.
Disclosures on Material Changes (e.g., Acquisitions): 26%
From time to time, companies face events that significantly affect their line of business and earning potential. These could include mergers and acquisitions or a material change in the company’s governance. The SEC has specified 31 such events that require companies to file a Form 8-K disclosure. The substantially strong preference for material change disclosures among poll participants lends further support to the notion that investors want more information in general.
Only the Full-Year Reporting Period: 17%
Most countries require audited full-year reporting. Quarterly reports, however, do not require an audit. In addition, a majority of companies tend to disclose detailed plans, presentations, and management discussions as part of their annual report. The third-place ranking for full-year reporting disclosures reflects their relative importance, but also the underlying preference among investors for more frequent disclosures.
All Semiannual Earnings Periods: 2%; Earnings Announcements Are Unimportant Events: 2%
Only 2% of respondents registered a preference for semiannual earnings reports. Another 2% believe earnings announcements are unimportant. These results are meaningful when compared to the other selections. The low support for semiannual reports reflects the perception among readers that they have comparatively lower informational quality. That only 2% think earnings announcements are irrelevant demonstrates that whatever their flaws, the disclosures listed above remain essential.
The subprime mortgage crisis occurred in large measure because of short-term greed and despite an abundance of disclosure, of informational sunlight. But a lack of sufficient disclosures can promote irrational speculation and insider trading, among other excesses. There is a need for investors, companies, and regulators to deliberate and agree on what information should be disclosed and to facilitate reporting mechanisms that shine light on how companies are truly performing and that can facilitate unburdened and efficient markets.
If you liked this post, don’t forget to subscribe to the Enterprising Investor.
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.