Capital Ideas - Summer 2013 - page 10

Summer 2013 | Capital Ideas
In financial reporting,
less is more...
nvestors demanded more transparency and account-
ability after Enron-era accounting frauds, but they
weren’t totally reassured by new annual and quarterly
reporting mandates. That impatience has translated
into constant pressure on public company executives
to provide frequent earnings guidance and to report
positive results as often as possible.
But is too-frequent reporting negatively affecting
long-term investor returns? That’s the contention ex-
plored in a working paper by Chicago Booth Profes-
Haresh Sapra
and colleagues from the University
of Illinois at Urbana-Champaign and the University of
Minnesota. The authors conclude there’s a happy me-
dium between not enough disclosure and too much
information delivered too often.
“Since markets are forward looking, any actions
that favor the short term at the expense of greater
long-term value creation would be effectively pun-
ished by lower capital market prices,” according to the
paper’s authors. Overreporting can
be costly and may end up a self-ful-
filling prophecy, magnifying the at-
traction to do anything to produce
quick profits. “Such pressures dis-
appear when reporting frequency is
decreased,” the authors report.
Sapra and his colleagues cite an-
ecdotal evidence along with empiri-
cal evidence they produced with a
model that uses probability theory
to analyze real cash flow returns to
an investment by a publicly traded
firm. Under the model, an invest-
ment decision is made under one
of two conditions: good or bad. An
executive chooses to invest after
getting a signal, a particular piece
of information such as a change in
business conditions that helps him
or her decide whether to make the
investment and what type of investment to make.
The researchers’ results show that long-term proj-
ects consistently have a higher present value of expect-
ed future cash flows (generally assuming a dollar today
is worth more than a dollar tomorrow). A short-term
project often looks attractive because it has a higher
probability of producing larger cash flows in early years
but that advantage diminishes over time. In other words,
short-term investments that flatter the bottom line may
appear beneficial, but in the long term they add less to
shareholder value. The authors show long-term projects
decisively beat short-term projects in the long term un-
der both good and bad investment conditions.
What is
The term refers to an excessive
focus on short-term results
at the expense of long-term
interests. When discussing the
causes of the financial crisis,
a related term was used by
columnist Eric Dash of the New
York Times: the I-B-G-Y-B-G
syndrome, “I’ll be gone; you’ll
be gone” before anyone will
have to answer for the toxic
mortgage securities building up
on bank balance sheets.
So how does this impact the way publicly traded
companies decide to report? Should companies be
reporting any more than is absolutely required, given
the feedback loop and short-termism that develops?
The research shows that the more frequently compa-
nies report, the more investors expect to see positive
results. The split between long-term investors and
those looking for early cash flows is constantly chang-
ing in large public companies, and executives can’t
please everyone all of the time. The research conclu-
sion: investors’ short attention spans hurt long-term
returns when company executives react to the clamor
for short-term results by reporting too frequently and
then attempting to meet heightened expectations by
any means possible.
Francine McKenna
Frank Gigler, Chandra Kanodia, Haresh Sapra, and Raghu
Venugopalan, “How Frequent Financial Reporting Causes
Managerial Short-Termism: An Analysis of the Costs and Benefits
of Reporting Frequency,” Working paper, April 2013.
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