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Apr 13, 2020

Opinion: Why the suspension of quarterly guidance should last beyond Covid-19

With a growing list of companies suspending earnings guidance, FCLT Global CEO Sarah Keohane Williamson explains why quarterly guidance can be problematic

As highlighted in IR Magazine’s new study, companies are increasingly suspending or cancelling earnings guidance. If this trend holds, it will be one of the few slivers of a silver lining of the last few months.

The market instability created by the Covid-19 pandemic has resulted in an about-face from many IR teams. From 2010 to 2019, 70 companies  on the S&P 500 stopped issuing quarterly guidance. By IR Magazine’s count, 54 companies have withdrawn quarterly guidance since March 16. What took the market almost a decade to do itself, Covid-19 will do for it in less than a month.

If this phenomenon is an indication of anything, it’s how ephemeral the practice of issuing quarterly earnings guidance is to begin with.

Quarterly guidance constitutes a critical channel through which short-termism impacts companies and capital markets. By yoking management teams to self-imposed short-term targets, quarterly guidance ensures companies will focus on this time horizon and that markets will notice.

There is mounting evidence that companies that play this quarterly guidance game suffer down the road. Recent research shows that short-term metrics may lead companies to prioritize decisions that will yield the most attractive results on a quarterly basis. Such an approach often results in companies sacrificing valuable investment opportunities and erodes the foundation of long-term, stable shareholders on which they depend.

A 2015 Harvard study helped confirm that companies get the investors they deserve. Focusing on short-term metrics attracts transient, short-term shareholders, ultimately increasing share price volatility. It is linked to lower earnings growth, a higher cost of capital and a lower return on equity when compared with peers that issue guidance with a long-term orientation.

Until this recent retreat from guidance, companies continued to issue quarterly EPS forecasts based on some long-held industry assumptions:

  • Issuing quarterly guidance helps reduce volatility

If the past two weeks have shown us anything, it’s that the opposite is true, and numbers from the previous decade confirm this. From 2010 to 2016, companies offering annual forecasting experienced lower volatility around earnings reporting periods when compared with those that issued quarterly guidance.

  • Issuing quarterly guidance improves companies’ valuations

It’s thought that issuing quarterly guidance improves companies’ valuations due to a 'management credibility' premium. Analysis of the S&P 500 found that guidance policy had no effect on valuation whatsoever.

  • Investors want short-term estimates

In repeated surveys of the buy side, earnings guidance given for periods of less than one year was consistently deemed irrelevant in evaluating a company’s future prospects. A 2016 Rivel Research Group survey gauged the interest of investors in earnings guidance. When asked the question 'How far into the future should companies provide earnings guidance?' only 7 percent of respondents picked 'less than one year'.

The use of quarterly EPS guidance is counterproductive in building the kind of investor base long-term companies need. It attracts the sort of transient, speculative investors that undermine long-term planning and pressure companies to neglect long-term opportunities. It leads companies to lose focus on what matters: the fundamental drivers of their business, the strategy they believe will unlock future value and the steps required to get there.

It’s a step in the right direction that such a large number of companies have opted to suspend guidance, regardless of the circumstances that caused them to arrive at that decision. Although we hope this crisis comes to a quick and abrupt end, we also hope to see the number of companies rise in IR Magazine’s next weekly update. And, of course, once the crisis has passed, they should not revert to their old ways.

Sarah Keohane Williamson

Sarah Keohane Williamson

Sarah Williamson is the chief executive officer of FCLTGlobal, a not-for-profit organization dedicated to encouraging long-term behaviors in business and investment decision-making. FCLTGlobal conducts research, convenes business leaders, develops...

CEO, FCLT Global