Let’s give a cheer — one, not three — to the Business Roundtable, which has finally come round to the realization that giving investors an estimate of next quarter’s earnings has created short-term mentality in Corporate America that has hurt the competitiveness of the U.S. economy.
The official acknowledgement came in an op-ed piece in the Wall Street Journal, and the requisite interview on CNBC, by Jamie Dimon, the chairman of the business lobby, representing the chief executives of the nation’s largest companies, and who, as chief executive of the nation’s largest bank, sits in the belly of the Wall Street beast. For support, he brought along celebrated value investor Warren Buffett, whose Berkshire Hathaway has long refused to provide estimates of future earnings.
“In our experience, quarterly earnings guidance often leads to an unhealthy focus on short-term profits rather at the expense of long-term strategy, growth and sustainability,” Dimon and Buffett wrote.
Only about a third of public companies — albeit many of the biggest — still offer Wall Street analysts a profit estimate for the next quarter. The rationale is that giving investors more information is always better than less, and that analyst earnings estimates tend to be more accurate as a result.
But in reality, the process takes up an inordinate amount of the time and attention of executives, who often play an elaborate game of lowering expectations so that they can exceed them at the end of the quarter and get a nice bump in the share price. Companies that fail to meet analyst expectations find that their stock is hammered.
Many executives have come to believe that companies that refuse to play the quarterly earnings game suffer a permanent discount to their share price, although the academic literature provides only weak support for that. There is plenty of evidence, however, that the focus on quarterly earnings discourages companies from making long-term investments in research and development and expanding into new products and new markets, while discouraging other companies from going public at all. Not surprisingly, companies that give quarterly guidance tend to attract a disproportionate percentage of short-term investors.
It is curious that the Roundtable chose this moment to announce its new policy, given that this is an old issue that, among experts at least, is largely settled. Even the CFA Institute, representing financial analysts, concluded long ago that quarterly guidance is an unproductive exercise. Over the years, numerous executives were heard to say privately that they would love to stop playing the quarterly earnings game if only others would as well (“But Mom, all the other kids were doing it!”). Now the Roundtable, which was founded to raise the standards of corporate behavior by solving such collective action problems, has given them some cover.
It is probably also no coincidence that the Roundtable was moved to action when profits and stock prices are at an all-time high. In April, when Caterpillar acknowledged that its first-quarter profits would probably be the “high water mark” for the year, traders drove its stock price down 6.2 percent on the day, dragging the rest of the stock market down with it.
But if the Roundtable is really concerned about the undue influence of Wall Street’s short-term traders on company behavior, it should reconsider its 30-year-old decision to declare maximizing value for shareholder as the sole purpose of a corporation. This mantra, which is now taught in every business school, repeated in every earnings call and annual report and waved around by every activist investor, has no basis in law or logic or any credible theory of how a company should be managed. And it is now the source of most of what has gone wrong with American capitalism — from the accounting fraud to the shabby treatment of workers and customers, from the orgy of share buybacks to the never-ending string of unproductive mergers and acquisitions.
The only reason that members of the Roundtable have allowed themselves to be pushed around by short-term traders and so-called “activist” investors is that they have bought into this morally and economically cramped version of corporate purpose. And they have embraced it for one simple reason — they’ve been bribed to do so with lavish pay packages tied to profits and share price that earlier generations of executives never dreamed of.
The question we should ask of the titans of the Roundtable is whether, in the face of declining trust in Corporate America, their new attitude toward quarterly earnings guidance is a first step toward a broader reconsideration of this credo of maximized shareholder value? Or is it a tactical retreat meant to forestall such a conversation?