Overthrowing the Tyranny of Quarterly Capitalism
Hillary Clinton is hardly the first person to decry so-called ‘quarterly capitalism.’
In the late 1980s, as the Japanese economy was soaring, Japanese companies were praised for taking the long view and critics of the U.S. system of mandated quarterly reports pointed to Japan’s structure as a model of balance and efficiency.
In 2011, as the U.S. financial system was emerging from the rubble left in the wake of the financial crisis three years earlier, the influential Harvard Business Review published an article titled ‘Capitalism for the Long Term.’
The author, Dominic Martin, a global managing director at consulting firm McKinsey & Co., called for sweeping reforms by U.S. companies, not least a shift away from the short-term focus generated by quarterly reports. “Myopia plagues Western institutions in every sector,” Martin wrote. “In business, the mania over quarterly earnings consumes extraordinary amounts of senior time and attention.”
Clinton, the front-running Democratic presidential candidate, said in a speech last month that many important elements of the U.S. economy – publicly traded companies and the executives that run them, shareholders and consumers – are held hostage to the “tyranny of today’s earnings report.”
“Everything is focused on the next earnings report or the short-term share price,” said Clinton. “The result is too little attention on the sources of long-term growth: research and development, physical capital and talent.”
To sum it up, the argument against quarterly reporting by publicly traded U.S. companies holds that CEOs, desperate to appease insatiable shareholders by keeping quarterly profits high, focus on short-term goals rather than investing into the long-term health of their companies.
Encourages a Short-term Focus
So instead of hiring more employees to conduct research and development to grow the company over the course of a 10-year plan, CEOs layoff thousands of workers and scale back on research and development.
Adding to the cynicism of critics of the current system is that many top CEOs’ compensation is directly tied to their companies’ stock price, so keeping that stock price high at any cost is as much a personal goal as it is a way of keeping shareholders happy.
“I think the quarterly focus encourages a short-term focus on profits,” said Andrew Stoltmann, a Chicago securities lawyer who often represents investors in cases of fraud and corporate malfeasance.
“It is extremely different than Japanese companies that take a long term view. This short term focus causes a slew of different problems for American companies and investors. Meeting the quarterly numbers becomes the driving force for companies rather than creating long term value,” Stoltmann said.
Possibly the most glaring example of a company that has ignored the siren call of the “big beat” quarterly report—that is an earnings report that comes in much higher than Wall Street had anticipated – is Jeff Bezos’ Amazon.com. (NASDAQ:AMZN) For nearly two decades Amazon has focused on growing the company, almost always at the expense of quarterly profits. Yet the stock continues – it’s up 73% in the past year alone.
Meanwhile, other big tech companies have found themselves under pressure from high-profile investor activists such as Carl Icahn and David Einhorn who want the companies to sharpen their short-term focus and generate more value for shareholders. Icahn has been critical of Apple (NASDAQ:AAPL) for supposedly not employing a handful of short-term methods to untap more of its stocks’ potential, and chipmaker Qualcomm (NASDAQ:QCOM) said recently it would slash 4,500 jobs as pressure mounts from activist shareholder Jana Partners.
Finding a Balance
University of Florida finance professor Jay Ritter said the pros and cons of mandated quarterly reporting has “been a topic of debate for decades.”
Ritter said the comparison to Japan has been going on since the 1980s when the Japanese economy was flourishing under corporate regulations that don’t require such frequent reporting ostensibly allowing for companies to take a longer view.
At the time, a similar rationale also provided justification for leveraged buyouts, in which privately-held companies purchased publicly traded companies usually in an effort to glean maximum value out of the company, a transaction to often led to massive layoffs and breaking up companies into smaller parts.
“It’s clear that some companies do distort their decisions” in an effort to generate consistently positive quarterly reports, said Ritter.
A counterpoint to the criticism, according to Ritter, is the analogy of final exams given to college students at the end of each semester or semi-annual performance reviews bosses give to their employees.
“Life is full of tradeoffs and for publicly traded companies there are periodic performance reviews,” he said. “If not for exams I wouldn’t have had to study so hard and without periodic reviews at work I’d probably spend more time on the golf course.”
Ritter noted that many companies don’t feel compelled to sacrifice long-term objectives simply to please Wall Street and shareholders and that the best companies find a balance between generating decent quarterly reports while still keeping a strong focus on the company’s long-term objectives.
“I don’t think there’s one-size-fits all. Companies that can explain to investors why earnings have gone down a few cents per share but have a legitimate story as to why that happened usually don’t see a price decline,” he said.