Libertarian law professor Richard Epstein has a new column up at the Hoover Institution Web site, taking on Al Gore on the question of "Sustainable Capitalism." Professor Epstein is hard on Gore's recommendation that companies should stop issuing quarterly earnings guidance. Professor Epstein writes:
One of their odd recommendations calls on firms to "end the default practice of issuing quarterly earnings guidance" on the ground that these reports encourage a mentality that "overemphasizes" short-term profits at the expense of long-term wealth creation. But that criticism shows a profound misunderstanding of how valuation processes work. In general, the scarcity of information is one of the key stumbling blocks toward making an accurate assessment of the current value of the firm. Faced with this difficulty, too little information—not too much information—is the central problem. Wholly without regard to any requirements of the SEC, firms publish quarterly reports to supply some information to improve the estimates that shareholders and lenders make of the businesses. The want of this short-term information should have the predictable effect of reducing the value of assets. There is no way to evaluate the long-term prospects of a firm by ignoring all short-term data.
It seems to me there that Professor Epstein is blurring the distinction between quarterly reports and guidance issued in advance of the reports. In respect of the guidance (not the reports) a 2006 McKinsey survey titled "The Misguided Practice of Earnings Guidance" found, "Contrary to what some companies believe, frequent guidance does not result in superior valuations in the marketplace; indeed, guidance appears to have no significant relationship with valuations—regardless of the year, the industry, or the size of the company in question." The same McKinsey survey reported that Google and Berkshire Hathaway didn't routinely issue quarterly guidance.
One approach would be neither to mandate quarterly earnings guidance nor to ban it, but to simply allow firms to handle the matter the way that management thinks is best. If shareholders don't like the approach to disclosure, they can either not invest or replace the management with one that takes a better approach. But regulating the issue by imposing either a requirement or a ban removes the whole activity from the realm of areas in which companies compete to win the favor of potential investors.
