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Letter to the editor

Stopping earnings guidance could make for more volatile markets

By The Associated Press
Published July 20, 2007

It's a farce to think that doing away with corporate earnings guidance will stop investors from betting on company profits.

Calls are coming from all sides - corporate America, industry groups, former securities regulators and even some shareholders - to end the practice of companies releasing earnings-per-share forecasts each quarter.

That would be a mistake. When companies provide guidance, they are putting their proverbial necks on the line, which resonates with investors more than the estimates from Wall Street analysts that tend to often mimic the corporate line.

Giving investors less information on which to base their earnings expectations could introduce more volatility into financial markets, and could potentially let companies bury potentially bad news for longer.

The issue surrounding earnings guidance isn't new, but has been gaining momentum in recent months. It surfaced this decade after the business scandals at Enron, WorldCom and others were in part blamed on executives cooking their company's books to meet their quarterly earnings-per-share estimates.

According to critics of guidance, those cases highlight why investors place too much emphasis on whether companies beat, meet or miss their profit estimates, down to the last penny per share. That leads corporate managers to perform creative accounting to get ahead, maybe by moving sales up or delaying charges.

Two-thirds of companies give guidance, according to a 2006 survey by the National Investor Relations Institute of 654 of its members. That's down from 77 percent in 2003.

In recent weeks, some prominent groups with big-name backing have made public statements about the need to end the guidance game.

Among them was the Committee for Economic Development, a Washington think tank whose members include former Securities and Exchange Commission Chairman William Donaldson and former New York Federal Reserve Bank head William McDonough.

"Quarterly guidance is at best a waste of resources and, more likely, a self-fulfilling exercise that attracts short-term traders," the committee said in a report issued in late June.

Certainly, the reasons for wanting to stop earnings guidance make some sense, but those might not outweigh the benefits of continuing such practices. For one, Wall Street research analysts, who help guide investors on what stocks to buy or sell, could be more prone to err in their earnings forecasts when the guidance goes away, according to a study from October out of University of Washington.

Companies that don't issue guidance have more opportunity to keep bad news under wraps for a lot longer - even though securities law requires them to make timely disclosures of material news - probably hoping it disappears before they have to report earnings.

The corporate scandals showed that transparency in financial dealings matters. Doing away with guidance could make the quarterly earnings seasons an even more surprising - and thus, volatile - time in the market.

[Last modified July 19, 2007, 23:31:51]