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The curse of the quarterly report.

Rather than constantly being distracted by looking at the scoreboard, we need to keep our eye on the ball instead. by Don Ritter

Over the years, corporate CEOs and other executives have complained to me about the numerous deterrents they face to making long-term investments. One of their most frequent objections has been about how the quarterly financial reporting requirement forces them to divert attention away from many activities that would improve their long-run competitiveness.

We urgently need to extend the time horizons of industry in the United States. There is too much pressure to maximize short-term profits and shareholder value, often at the expense of long-term competitive viability.

A large and growing share of the capital of U.S. firms is owned by mutual funds and pension. funds. The managers of these funds are under constant pressure to maximize the current value of their portfolios since this is the principal criteria by which their performance is judged.

Because portfolio managers and stockholders evaluate a company's performance on the basis of quarterly financial reports, managers tend to emphasize short-term profits even when it raises possible conflicts with long-term investment.

A preoccupation with short-term business horizons worked before, when America dominated the world economy. But such an approach seems ill-suited to a world characterized by rapid change, global competition, and a constant need for innovation. Success in most industries increasingly requires an organizational commitment to compete in the marketplace on technological grounds. And developing improved technology requires long-term investment in research, development, commercialization, and acquisition of new capital equipment.

But there can be a tendency to underemphasize investment in long-term technologies and projects when such investment reduces short-term profits. Technological advance is often a long-term, high-risk venture and frequently does not lend itself to the early high rates of return that are expected under the quarterly financial reporting cycle. Moreover, short-term business horizons can lead to underinvestment not only in technology development but in human resources, improved quality of products and processes, and capital assets.

Success in trade is also the result of meticulous preparation. Frequently, exceptional patience is needed before the rewards of a major export campaign are recognized. Such commitment may be diminished for an executive who is concerned with the next quarterly earnings report.

My Long-Term Investment Promotion Act would amend the Securities Exchange Act of 1934 by eliminating the requirement for corporate quarterly reporting of financial status. The bill was introduced in order to help extend the time horizons of industry by discontinuing a public policy that is widely perceived as fostering the short-term mentality of American business: the mandatory quarterly report.

Firms would still be required to report their financial standing on an annual basis, and could voluntarily continue to report quarterly, if they so desired. However, those firms that seek relief from constantly having to compromise their long-term strategies for short-term appearance would now have the option to do so.

Concealing Information?

Some have claimed that eliminating quarterly financial reporting would create an opportunity for companies to conceal negative information from their shareholders. This was, in fact, why quarterly reporting was first mandated in the deep Depression year of 1934, when it was not known whether companies would still be around in 90 days. Yes, there is potential abuse. But we need to recognize the huge gulf that exists in the financial health of the broad-spectrum companies in the American economy.

Perhaps firms might have to demonstrate a strong debt-to-equity position or some similar measure in their annual report in order to suspend their need to report on a quarterly basis in the following year. But why penalize the competitiveness of a company that is taking the long view - by investing for the future, taking prudent risks, training its employees, and committing to Total Quality Management - by making them adhere to the same rigid reporting standard as the firm that is less well-managed?

Some have objected that my bill would put individual investors at a disadvantage in comparison to their larger institutional brethren whose extensive networks of contacts would seem to ensure a continuing stream of financial data. But I think this just serves to further substantiate my feeling that in the U.S., investment is viewed largely as akin to a sophisticated form of gambling.

We need to change this perception. Investment needs to be perceived as what we need to do to build for the future, lay the ground-work for a more competitive economy, provide for better productivity and wages of our workers, and improve the standard of living of all Americans.

We need to think of international competitiveness as a tennis game. Rather than constantly being distracted by looking at the scoreboard, we need to keep our eye focused on the ball instead. Eliminating quarterly reporting would be entirely consistent with this goal.

Competitor's Horizons

In contrast to the short-term preoccupation in the U.S., firms in many of our most successful country competitors such as Japan and Germany typically operate under much longer time horizons, in some instances spanning many decades. I don't think it is a coincidence that companies in these and other countries report their financial status on a semi-annual or annual, rather that quarterly, basis.

In the recent report of the U.S.-Japan Structural Impediments Initiative, the two governments each recommended that the other revise its public policies in certain areas in order to help alleviate impediments to more balanced trade between the two countries. The government of Japan offered formal recommendations in such areas as saving and investment patterns, corporation investment activities and supply capacity, and research and development.

In the area of corporate behavior, the Japanese delegation observed that "in order to make the U.S. industries competitive, it is necessary to eliminate budget deficit and also in a business area, to transfer priority for short-term profit to long-term outlook. The U.S. government (USG) should make best efforts to include the U.S. firms to attach the highest priority to long-term behavior." Therefore, the government of Japan formally recommended that: "The USG should also make improvements in an institutional area for inducing long-term corporate behavior such as making profit reporting system of corporations less frequently than quarterly."

Isn't it interesting that the Japanese government pushes the long-term view even in this country! Perhaps it's not surprising, given their huge investments and markets here.

Instead of promoting the frequent buying and selling of existing financial securities, public policies need to do more to promote the economic growth that contributes to the creation of new companies and additional securities. Instead of encouraging firms to sell off assets, slash their R &D, and lay off their employees to look good every three months, government policies should encourage patience, perseverance, and the belief in future rewards. The elimination of the quarterly report requirement is an important step in this direction.

Last year, the Senate Finance Committee held hearings on "The Effects of Short-Term Trading on Long-Term Investments." One of the witnesses was Andy Sigler, chairman of Champion International Corp. He testified with the type of complaint often heard privately but not frequently heard publically. Sigler said that two years ago his company announced a $500 million plan to expand its Cortland, Ala., plant. The expected payout from the project was exceptional and widely recognized. But the day after the project was announced, his stock fell 10% and two large institutional investors sold all their stock in his company.

A Better Handle

It looks like there's a lot of short termitis out there. As minimum, I think we need to focus much more research on this subject. We really ought to get a better handle on the problems that result from quarterly reporting. I know that not all firms think it's a problem, but others sincerely believe that they often have to compromise their long-term best interests by taking actions that only temporarily elevate their earnings or the value of their stock. Let's try to document some of the specific examples where this has been the case.

The Council on Competitiveness has a major joint study going with the Harvard Business School on the "Time Horizons of American Management." This study is sure to go a long way toward bringing out the problems of our short-term, quarterly report-assisted fixation. It should open up the long-term vs. short-term issue to a very healthy debate. My bill may be only the first of an emerging series of proposals designed to lengthen our planning and investment horizons in the interest of improving our international competitiveness.

Quarterly Reporting:

Useful and Essential

When Rep. Don Ritter (R., Pa.) introduced his bill (H.R. 2910) in the Congress to repeal the authority of the Securities and Exchange Commission to require quarterly reports, he said, "Wall Street probably won't like this." He was right. The Association for Investment Management and Research (AIMR), the professional organization for 21,500 financial analysts, portfolio managers, and investment advisers, strongly opposes this legislative proposal. The following is its position statement.

Quarterly reports long ago proved their usefulness as essential parts of the continual disclosure system that has given depth and liquidity to U.S. capital markets. To eliminate this requirement would not serve to "commonize" global capital markets. Instead, it would launch a "race to the bottom," to the detriment of shareholders and corporations alike.

Furthermore, quarterly reports in and of themselves have not created a short-term investment outlook. That responsibility lies with those who create and use the information. While securities analysts deserve some blame for an overemphasis on quarterly results, they do not deserve it all. Too many managements have explicitly promised consistent quarterly earnings gains; in return, their companies have obtained premium price-earnings ratios. Eliminating quarterly reporting to "cure" a short-term investment focus would, in effect, be treating the symptoms and not the underlying cause.

AIMR supports the retention of quarterly financial reporting for these reasons:

1. Quarterly reports provide analysts and other investors with opportunities to refine their estimates of future operating results, compare performance with management forecasts and objectives, and direct attention to particular areas of concern. According to an AIMR survey, "eight quarters of data are likely to indicate emerging trends that are invisible in two years of data."

2. As corporate owners, shareholders have a right to the same level of performance information that corporate management enjoys.

3. Fairness in the dissemination of information to all classes of investors demands reporting at intervals no longer than three months. Quarterly reports reduce the opportunity for trading on privileged information. Such trading erodes the integrity of the marketplace.

4. Quarterly reports alleviate the volatility that would be inherent in the market were only annual or semiannual reports to be required. Studies have shown that release of annual results has a limited effect on market prices; three quarterly earnings reports have taken out much of the "surprise" element. Reduced frequency of reporting would likely increase the volatility of securities prices around the time of earnings reports.

5. Quarterly reports enhance the long-term competitive viability of U.S. companies in world capital markets. One of the reasons that U.S. securities offerings are so well received overseas is the added level of disclosure that characterizes U.S. financial reporting in contrast to the lesser levels that prevail outside of North America.

Don Ritter is a Republican congressman from Pennsylvania currently serving his seventh term in the U.S. House of Representatives. Before coming to Congress, he taught at Lehigh University, Bethlehem, Pa., managed the development of new research programs there, and was a consultant to industry in the field of materials and manufacturing. Ritter serves on the Science, Space and Technology Committee and two of its subcommittees; the Subcommittee on Environment, of which he is the ranking minority member, and the Subcommittee on Technology and Competitiveness. He is Chairman of the House Republican Task Force on Technology and Policy.
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Title Annotation:Chairman's Agenda: Governing for Shareholder Prosperity; includes related article
Author:Ritter, Don
Publication:Directors & Boards
Date:Mar 22, 1992
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