Critics say Buffett-Dimon plea to end quarterly guidance won’t end ‘short-termism’

Two of the world’s most influential business leaders — billionaire investor Warren Buffett and Wall Street banking boss Jamie Dimon — on Thursday made an urgent call to fellow executives: stop giving out quarterly guidance and start focusing on long-term results.

Critics, however, say that while their call is well intentioned, it misses a crucial point: What Buffett and Dimon decry as “short-termism” isn’t the result of quarterly guidance, it’s the result of quarterly earnings reporting — a practice that Buffett, the chairman of Berkshire Hathaway  and Dimon, chairman and chief executive of JPMorgan Chase & Co. took pains to endorse.

“Our views on quarterly earnings forecasts should not be misconstrued as opposition to quarterly and annual reporting,” the pair wrote in a Thursday guest column in The Wall Street Journal. “Transparency about financial and operating results is an essential aspect of U.S. public markets, and we support being open with shareholders about actual financial and operational metrics.”

But reporting earnings on a less frequent schedule, for example once every six month, would be a better solution to short-termism in equity markets, according to John Kay, a U.K.-based economist and author of “Other People’s Money: The Real Business of Finance,” a critique of the outsize role of the finance sector in Western economies.

“What is changing in three-month intervals does not tell us anything about how a company is positioned to deal with long-term growth,” Kay said in an interview with MarketWatch.

In their critique, Buffett and Dimon argued that financial markets “have become too focused on the short term. Quarterly earnings per share guidance is a major driver of this trend and contributes to a shift away from long-term investments.”

How guidance works

Since corporate earnings are measured against consensus analysts forecasts, it is often expeditious for companies to attempt to massage those expectations. Over the decades, companies have become so good at the task that earnings have beat forecasts at a faster rate over time, according to Jill Carey Hall, equity and quant strategist at Bank of America Merrill Lynch.

“There is a tendency by corporations to set conservative numbers so that EPS beats come through,” Hall said.

But it appears that investors also view guidance as a sign of transparency and reward such companies with higher valuations relative to companies that don’t issue guidance.

“History suggests that beginning in mid-2000, companies that regularly issue profits guidance have begun to trade at a premium on book value to those that do not guide at all. This premium may be granted for transparency, and we have found that it is generally most pronounced in cyclical sectors,” Hall said.

Nonetheless, companies are already making less use of guidance, according to Hall.

As seen in the chart below, since early 2000, when S&P 500  companies almost always issued quarterly guidance, the frequency has steadily declined. Now, only about a third of companies provide guidance each quarter.

The U.K. experience

Kay was asked by the U.K. government to review activity in U.K. equity markets and its impact on the long-term performance and governance of U.K.-listed companies. Kay recommended the elimination of mandatory quarterly reporting in favor of semiannual reporting and phasing out of management guidance on earnings expectations.

His other recommendations included the adoption of a stewardship code, the establishment of a forum for collective engagement by investors, the clarification of fiduciary duties of trustees and their advisers, and the rebating to investors of all income from stock lending.

In 2014, the U.K.’s Financial Conduct Authority removed its quarterly reporting requirement, though more than 90% of U.K.-listed companies continue to report on a quarterly basis.

“Many of these companies are also listed in the U.S. and have to report quarterly anyway, so they continue to report in the U.K.,” said Kay.

Ultimately, the move away from short-termism would require many other reforms in the finance industry, he said, including aligning incentives of investors and companies.

“Ideally, analysts would be employed by the buy-side and they would be experts in the business, rather than finance. As it is, analysts are trying to guess what other analysts would forecast,” he said.