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People and MarketsCommentGC View

Blackouts are the problem, not quarterly reporting

Initiatives by US president Donald Trump to slow the corporate earnings reporting cycle are aiming for the wrong target. Less frequent reporting might be helpful to real estate developers with a penchant for bankruptcy, but three-monthly numbers are adequate for mainstream capital markets. That doesn’t mean, however, that the system is perfect.

Not much unites Donald Trump, carbon-spewing president of the United States, who is happily trying to reopen coal mines and drill for more oil, with “St Paul” Polman, the chief executive of Unilever, a Davos regular who’s made corporate sustainability the centrepiece of his nine years in charge.

Both, however, distrust quarterly reporting for public companies. Polman has argued against quarterly reporting for Unilever since he took over, claiming investor time horizons had become too short and turnover too rapid. Trump, meanwhile, tweeted last week that he’d asked the Securities and Exchange Commision to consider whether US public companies ought to be forced to report every three months. Jay Clayton, Trump’s chosen SEC chairman, confirmed the agency was looking at the changes.

One suspects their motivations for disliking regular reports may be somewhat different. Unilever is the very definition of a mature, defensive stock. Returns on capital are high, the dividend is rock solid, and leverage is low. Trump’s tangles with the capital markets, cluster at the, ahem, "higher beta" end of the scale, featuring mainly non-recourse loans against speculative commercial property, with a couple of bankruptcies thrown in to boot.

Regular reporting is certainly an irritant. GlobalCapital finds it to be so, and we simply have to read quarterly reports, not make investment decisions or worse, prepare them. It clearly takes management time and resources to meet quarterly deadlines, manage guidance, meet analysts and the like, and that may well take attention away from running the business.

Private equity firms, indeed, claim this is a big part of the reason take-privates can be a success (they’d rather blame quarterly reporting than talk about their penchant for adding a ton of leverage). Businesses can be restructured and efficiencies extracted out of the public gaze. For some firms, quarterly reporting undoubtedly does deter them from raising funds in the public markets.

But it is an annoyance rather than a fatal flaw. The number of otherwise healthy businesses brought low by an excess of quarterly reporting is dwarfed by the number of investors who’ve been able to get out of positions in a timely fashion thanks to the disclosure forced by regular, audited updates.

To put it another way, it’s an asymmetric pay-off. To cut the annoyance down a little for everyone will lead to an increased number of serious failures to slip through and sandbag investors. Companies large enough for main market listings ought to easily be able to hand much of the pain of reporting to dedicated IR departments.

The claims of short-termism hold even less water. Simple stats like average holding time are deceptive — they measure an average of investment horizons that span from high frequency trading firms with long-only real money. The buy-side has become more passive and more concentrated in the past decade, and that means longer-term holdings where it really matters, even if average holding time has gone down.

The top holders of almost any large cap stock are drawn from among the usual institutional investors suspects, split between active and passive holdings, and none of these buyers are in the habit of vast lurches in positioning over quarterly reports.

At the other end of the spectrum, activism is on the rise. And while this might involve pushing for shareholder-friendly moves like special dividends or buy-backs, it’s hard to think of it as short-termist. Activist hedge funds have typically done deep dives and due diligence on their target, looking at multiple public and private sources to figure out a position. They’re not in the habit of being fooled by a couple of heavily juiced non-GAAP numbers in a specific quarter.

Moral architecture

But the system does need a tune-up. There’s little reason to end quarterly reporting for the biggest, most established firms, but there’s no reason why it should be standard one-size-fits-all for any public firm. Indeed, outside the US, it is more flexible — but the ties of culture and custom still lead to issuers producing quarterly trading statements which look awfully results-like to the casual observer.

Private markets, especially for tech firms, are now large and liquid, and can support companies at scales once thought impossible. Uber’s valuation is harder to compute than if it were public, but it’s likely north of $50bn, and clearly hasn’t been hamstrung by a lack of listing. Insiders can sell stock, and investor reporting does leak out. 

Big tech is increasingly opting to stay private, perhaps in part because of reporting — though also because the menu of options involved in going public doesn't suit them.

Stock market regulation has not kept pace with the blossoming of the private market — firms are either public or not, with few fine gradations along the way. Frequency and depth of reporting could be seen as something akin to control rights — a feature for the market to price, rather than an essential piece of the moral architecture of markets.

The most serious problem of quarterly reporting, however, comes largely in the bond market, not the equity markets. A big bond market borrower can easily be in the market 10 times a year or more, and every time, it must navigate around the blackout periods, which come four times a year. This isn't necessarily mandated in law — but it's so widely observed that it might as well be.

As well as blackouts, strip out the thin markets in mid-August and late December or the week before investors have their own quarter-end, drop a few weeks with big central bank announcements expected, ditch a month or two for the the political crisis du jour, consider Golden Week, Catholic saint’s days, Thanksgiving and the various other drawn out US public holidays, UK bank holidays, and then see how many market windows are left.

That leaves bond markets frequently lurching from feast to famine and back again. Borrowers can find themselves paying up because they’re jostling for attention, or twisting and turning through niche currencies and private placements in an attempt to avoid clogging up markets.

Blackouts make bond markets more prone to indigestion, less able to price risk correctly, and less efficient as a venue to raise finance.

They’re also a disproportionate response to a tiny and trivial problem. Investors asked to buy a bond during the weeks before a reporting period are indeed taking a risk — the numbers could be starkly better or worse than expected. But they’re always taking essentially the same risk outside blackout periods. Treasury teams inside a company always have better business information than third-party investors, and, if investors are worried about that during blackout, then let them price it, rather than enforcing closed periods. If final reported debt figures need updating because of last minute issuance, that’s why God invented footnotes.

Blackouts also purport to manage insider trading by those with knowledge of the upcoming results — but that’s easy enough to solve too. Regulations already exist to manage trading by corporate insiders, and, anyway, its perfectly possible to stop management, say, ditching stock ahead of bad numbers, while still allowing routine funding trades to go ahead. Improved artificial intelligence and ever-more detailed transaction reporting ought to be better than ever at ferrreting out individuals who don’t stick to these rules.

Unlike in the nebulous claims about management focus and short termism, there is, then, a real problem to solve here, and one which could really boost the functioning of capital markets. It’s related to quarterly reporting, but can be separated, and it should be.

Numbers every three months set a good balance. But quarterly reports are not for everyone, and they do have negative effects. But rather than scrap it entirely, or set the balance at six months market-wide, we should think about specific problems, such as blackout, and focus on solving those.