Many financial experts say that the practice of providing quarterly earnings guidance is creating an unhealthy obsession with short-term results that hurts corporate performance. Those experts include market veterans Warren Buffett and Jamie Dimon, who recently authored a Wall Street Journal think piece urging companies to resist calls for such guidance.
Their argument: “[C]ompanies frequently hold back on technology spending, hiring, and research and development to meet quarterly earnings forecasts.”
But according to MarketWatch contributor Mark Hulbert, removing the short-term blinders that companies wear nowadays might not significantly improve their performance. In a recent column, he cited a study published several years ago in the Journal of Financial Economics titled The Evolution of Capital Structure and Operating Performance after Leveraged Buyouts: Evidence from US Corporate Tax Returns.
The study’s authors were able to obtain access to the corporate tax returns of more than 300 previously public firms. With that information, they deduced the companies’ operating performance after they were rid of the pressure to meet quarterly earnings expectations.
“The researchers compared each of these private firms with a carefully selected group of public companies that were otherwise similar,” Hulbert wrote. “On average, the private firms did not perform any better after going private than the comparable firms that remained public.”
Jonathan Cohn, an associate professor at the University of Texas and co-author of the study, reportedly said in an interview that the results don’t represent a final answer. The findings reflected a maximum of three-years of post-buyout performance, for example, and the firms that were studied might go on to do better over a longer time horizon.
“[A]t least over the short-term as well as the intermediate-term of up to three years, eliminating short-termism doesn’t appear to improve operating performance,” Hulbert concluded. Based on the results of the study, he suggested, even relaxing the current practice to three-year guidance would not wean companies from their short-termism.
But that doesn’t mean investors can’t benefit, he added. Some companies might keep their eye on the long game despite their need to provide investors with quarterly earnings guidance; that means investors who can look beyond quarterly figures stand to benefit if those companies suffer in the short term and end up with undeservedly low share prices.
“The question then becomes whether any of us has the courage to focus on the long term when short-term performance suffers,” Hulbert said. “No one is forcing us to favour companies that meet or exceed their quarterly earnings guidance, but it’s human nature to do so.”
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