Scrap quarterly reports?
Financial quarterly reporting is under discussion, both in the Netherlands and in Europe. It is claimed that they encourage shortsightedness and a quarterly "rat race". Scrapping quarterly reporting is not the right solution, states Dr. Philip Joos, professor at the TIAS Executive Master in Finance and PhD researcher Ties de Kok of Tilburg University.
In March 2016, the biggest British institutional investors asked the FTSE 100 companies to stop their quarterly reporting. The Investment Association's report (this represents 5.5 trillion pounds of capital and is the lobby group for the institutional investors in the United Kingdom), makes a radical demand of companies to increase productivity by focusing more on long-term targets.
In the Netherlands, financial quarterly reporting has recently come under discussion after minister Dijsselbloem's decision to no longer make them mandatory. Dijsselbloem also argues that quarterly reporting encourages shortsightedness. Paul Polman of Unilever talks about the quarterly "rat race" and in 2009 already stopped publishing these intermediate reports.
Scrapping is not the right solution
We argue that scrapping quarterly reporting is not the right solution. As a reporting period, the quarter is indeed problematical, because on the one hand it is not long enough to immediately stimulate long-term thinking, and on the other hand it is not short enough to prevent reporting deadlines imposing a short-term focus. So we envisage a better solution in a reporting model in which periodic long-term reports are combined with real time intermediate status reporting. We call this the frequency paradox.
Quarterly reporting in the 21st century
Scientific proof and public opinion surrounding quarterly reporting are characterized by a combination of opposing arguments. The diversity in these arguments illustrates the presence of a greater underlying problem. Due to economic, technological and social developments, the current reporting paradigm is getting increasingly out of step with the changing demand for information. The key to this information problem lies in finding a sustainable balance between on the one hand the information seekers and on the other hand the information providers.
In order to come to grips with a contemporary interested party's demand for information, it helps to consider three aspects:
- The information content (what): The modern business process is being increasingly characterized by our knowledge economy. Here value is often generated by intangible assets, such as human capital and R&D. These are included only summarily in traditional financial reporting.
- The medium (how): As a result of the rise of the digital age and mobile communication technologies, the amount of information and the manner in which this information is presented and consumed are undergoing significant changes. These economic and technological developments are moreover accompanied by increasing public interest for responsible and sustainable business.
- The time component (when): Investors increasingly expect to be able to obtain timely financial and non-financial information in a digestible format, regardless of the location and time. Today, the latter forms one of the greatest challenges for the investor relations departments of listed companies.
The key to the information problem
The degree in which companies meet these changing demands for information depends on two factors. The first factor is normative and comprises the legal framework for information dissemination towards investors. The second factor concerns the voluntary business reporting which is preceded by a cost-benefit analysis. Academic research has shown that a tenable reporting model is strongly dependent on both these factors. For this reason, reducing the reporting frequency is not a good solution for the bigger underlying problem.
For instance, investor relations departments already have their hands full keeping the market's expectations in check between quarterly reports. A (half) yearly report would only make matters worse. That also explains why Unilever's decision to stop publishing financial quarterly reports has not been copied much since 2009. Real progress can be gained by not only looking at when, but also at how to tackle the underlying information problem.
A combination of long-term and real time
The reporting model which we propose, combines periodic long-term reports with real time intermediate status reporting. The annual report discusses the company's long-term targets and provides a framework as a basis for interpreting intermediate updates. The status of so-called key performance indicators (KPIs) which are necessary for providing an estimate of the company's long-term health are presented in the form of a website or dashboard.
This also enables financial and non-financial KPIs to be reported on next to each other. The update frequency is separately defined for each information element, dependent on the cycle deemed to be relevant. For instance, the number of sales can be updated on a daily basis, while for a KPI such as employee satisfaction, a weekly or monthly update would be more logical. The conceptual idea of continuous reporting overcomes the shortsightedness which is caused by periodic reporting deadlines and moreover fits in better with the changing demand for information.
Necessity for dialog between the academic world and practice
The reporting model which we have sketched in this article, offers a more progressive solution in the debate surrounding quarterly reports. At the moment we still know little about the consequences that real time reporting can have for parties such as investors, companies, accountants and legislators. So this offers an ideal opportunity for academics to enter into a dialog with the supply and demand parties in the information market.
About the authors:
Prof. dr. Philip Joos is professor of accounting at TIAS and is part of the TIAS FinanceLAB. Ties de Kok is PhD researcher at the Accountancy department of Tilburg University.
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