Why ending quarterly reporting will not solve the stock market short-termism problem…but may be justified for other reasons

Should further restrictions be placed on financial reporting timeframes in an effort to curb stock market short-termism? This question was on the agenda at the recent event hosted by the University of Antwerp Law Faculty, Harvard Law School and ECGI. At this event, I spoke on why such restrictions will not solve stock market short-termism concerns but may be justified on other grounds.

As background, both the EU and the UK have ended mandatory quarterly financial reporting and instead allow listed companies to provide half year reporting. These changes were made in large part due to concerns raised by policy makers that quarterly (i.e., three-month) reporting timeframes were contributing to the perceived problem of stock-market short-termism. In the UK, Sir John Kay, a leading economist, recommended in the Kay Review that mandatory quarterly reporting be removed in order to reduce perceived pressures for short-term decision-making arising from excessive – e.g., quarterly – reporting of financial performance. In the rationale for removing mandatory quarterly reporting in the EU, the EU Parliament/Council stated in Amendments to the Transparency Directive that, “[i]n order to encourage sustainable value creation and long-term oriented investment strategy, it is essential to reduce short-term pressure on issuers and give investors an incentive to adopt a longer-term vision”.

The UK changes took effect in 2014 as a result of amendments to the FCA Handbook. The EU changes took effect the following year and provided that EU listed companies only require annual, and half year financial reports. Of note, although optional reporting is available in the EU, some EU member state exchanges continue to require quarterly reporting, so the effect may be limited in practice. There appears to be an increasing uptake on moving to semi-annual reporting by UK companies, but further research is required to verify this trend. See Owen Walker, The Long and Short of the Quarterly Reports Controversy, Financial Times (July 1, 2018), in which the author indicates that UK listed companies are moving from quarterly to semi-annual reporting. Similar research on the use of optional semi-annual reporting by EU listed companies would be useful to determine market interest in longer reporting periods.

The EU is currently discussing more draconian measures, including ways to discourage or ban listed companies from reporting on a quarterly basis (see the recommendations in the 2022 EU Commission Report). In contrast, the US continues to require quarterly reporting in the form of SEC 10-Qs. However, following broader discussion, including by former U.S. President Donald Trump, the US SEC released a Request for Comment on Quarterly Reporting in 2018. Comments received were mixed, with some stakeholders expressing concern about ending mandatory quarterly reporting, and others being supportive of optional longer reporting periods, including tri-annual reporting. Given this unsettled landscape, it is worth revising whether a move away from mandatory quarterly reporting is an effective remedy for stock market short-termism concerns.

In his recent book, “Missing the Target; Why Stock Market Short-Termism is not the Problem”, Mark Roe boldly asserts that as an answer to short-termism, “ending quarterly reports will not have the desired impact: it is a small and bent arrow unworthy of its target”. He goes on to argue that this approach “requires one to believe that if public firms reported results every six months instead of every three months, then they would make more five-year investments in plant and equipment and throttle up R&D…[S]ix months is not the long-term”. Roe’s book presents a case for why the evidence of actual harm from stock market short-termism is minimal at best. Although compelling, harms from short-termism are notoriously challenging to measure given the difficulty of isolating the impact of short-termism, and testing the hypothesis that harm is caused against a fictional market without short-termism.  

Regardless, even if we assume there is problematic stock market short-termism, will removing mandatory quarterly reporting provide a solution? In my book, Stock Market Short-Termism: Law, Regulation and Reform, I present a dual pathway for effective reform. Specifically, in order to effectively combat stock market short-termism, the reform must either: (1) reduce actual or perceived discounting of future returns by ‘enlightening’ investors on the potential harms of a short-term bias; or (2) cut off the transmission of investor short-termism by: (a) insulating managers; AND (b) reducing their short-term compensation. 

Following Pathway 1, the end of mandatory quarterly reporting may act to ‘improve’ or ‘enlighten’ investors (and asset managers) by forcing a longer-term approach. However, the impact may be minimal as reforms are voluntary, and not in place in the US and certain EU stock exchanges. Outright prohibitions on quarterly reporting could be more effective, but a ban is unlikely to be justified given the evidentiary issues on the harms of short-termism. Following Pathway 2, the end of mandatory quarterly reporting could assist with insulating company management from short-term pressures but would not be effective in the absence of restrictions on executive compensation based on quarterly or short-term metrics.

To conclude, optional longer reporting timeframes are not an effective counter to stock market short-termism, and the evidence of the harms of stock-market short-termism does not justify further regulatory intervention. Meanwhile, there may be strong policy reasons to further remove or restrict quarterly reporting, most significantly to reduce administration costs, but the short-termism rationale for doing so is largely rhetoric. Further, any change to reporting timeframes should be weighed against potential negative impacts to capital market transparency. Although not a small and bent arrow, the regulatory changes to quarterly reporting do certainly miss the mark as a remedy for short-termism.

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By Kim Willey, adjunct professor at the University of Victoria Law Faculty and a partner with the corporate law firm ASW Law Limited.

If you would like to read further articles in the 'Short-Termism Special Issue' series, click here

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