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The practice of U.S. public companies issuing quarterly earnings-per-share (EPS) guidance is coming under increased scrutiny and criticism. For more than a decade, analysts and investors have eagerly anticipated these forecasts -- and the ensuing stock price fluctuations -- every three months (or more often, as adjustments are made). Opponents of providing quarterly EPS guidance have argued that the pressure it puts on companies to meet or exceed the forecasts each quarter results in "short-termism" to the detriment of long-term, value-creating business strategies. [FOOTNOTE 1] Short-term investors, such as hedge funds, tend to like forecasts and earnings guidance because the differences between actual and forecasted EPS may provide profitable trading and arbitrage opportunities. [FOOTNOTE 2] As the anti-quarterly-guidance movement gathers steam, companies -- whose executives, in general, would be delighted to avoid the time-consuming and stressful process of preparing earnings forecasts at least four times per year -- appear to be trending away from quarterly EPS guidance toward a more nuanced, individualized disclosure model.

Two high-profile reports were recently issued calling for the permanent elimination of quarterly earnings guidance. In March 2007, an independent commission established by the U.S. Chamber of Commerce issued a report in which one of the primary recommendations focused on ending the practice of quarterly guidance; [FOOTNOTE 3] and last month, the Aspen Institute released a set of principles for long-term value creation that advocated against the use of quarterly estimates, and was signed by a wide-ranging coalition of business and investor organizations, large companies, pension funds and trade unions. [FOOTNOTE 4]

The practice of issuing quarterly earnings guidance began in the early 1990s, driven in part by demands from institutional investors and research analysts for increased corporate transparency. [FOOTNOTE 5] Unfortunately, quarterly EPS forecasts have become the proverbial tail that wags the dog. As Daniel Vasella, CEO of Novartis, has commented, "The practice by which CEOs offer guidance about their expected quarterly earnings performance, analysts set 'targets' based on that guidance, and then companies try to meet those targets within the penny is an old one. But in recent years the practice has become so enshrined in the culture of Wall Street that the men and women running public companies often think of little else. They become preoccupied with short-term 'success,' a mindset that can hamper or even destroy long-term performance for shareholders." [FOOTNOTE 6]

Replacing quarterly earnings guidance with company-specific disclosure of results and trends may produce a pattern of communication with investors and analysts in which companies provide higher-quality, more useful information more frequently, thereby increasing overall corporate transparency while still serving the interest of shareholders in long-term value creation and growth. As an interim step, companies may choose to provide annual guidance in lieu of quarterly forecasts.

The Commission on the Regulation of U.S. Capital Markets in the 21st Century (the "Capital Markets Commission") recently made a number of recommendations, including recommending that "public companies ... stop issuing earnings guidance or, alternatively, move away from quarterly earnings guidance with one earnings per share number to annual guidance with a range of EPS numbers." [FOOTNOTE 7] The Capital Markets Commission further recommended "that public companies promulgate additional information on their long-term business strategies as well as on any material developments between quarterly announcements of actual earnings." [FOOTNOTE 8] Like most opponents of quarterly guidance, the Capital Markets Commission stated its belief that quarterly projections create undue pressure on businesses to meet the targets, even at the expense of value-creating long-term projects. The Capital Markets Commission noted that many companies eliminate quarterly guidance only after they have already missed their targets, so that ceasing to provide guidance generally is viewed negatively by the markets. This effect would be removed if all public companies stopped offering quarterly guidance; the Capital Markets Commission hopes to incite a mass movement in this direction and argued that this would benefit investors and the economy generally by permitting companies to focus on long-term value creation.

The Aspen Institute recommended in general terms that companies "focus corporate-investor communication around long-term metrics," i.e., "communicate [with investors] on a frequent and regular basis about business strategy, the outlook for sustainable growth and performance against metrics of long-term success" and "avoid both the provision of and response to estimates of quarterly earnings and other overly short-term financial targets." [FOOTNOTE 9]

Many top executives agree with the Capital Markets Commission and the Aspen Institute. A Financial Executives International survey, undertaken in response to the Capital Markets Commission Report, found that more than 60 percent of the chief financial officers polled believe that public companies should stop providing quarterly guidance. The group reportedly favored providing a range of EPS forecasts annually, as recommended by the Capital Markets Commission. [FOOTNOTE 10] However, most chief financial officers do not expect that their companies will cease to issue quarterly guidance anytime soon. [FOOTNOTE 11]

Opponents of eliminating quarterly guidance typically cite transparency as a rationale for maintaining guidance. In addition, some opponents believe that the practice of quarterly guidance imposes discipline on companies and shows that they are in control of their business; other opponents argue that earnings guidance removes, rather than increases, short-term stock price risk, that managers should be able to convince shareholders to see the long-term benefits of their strategies, and that truly excellent managers will not allow earnings guidance to distract them from long-term growth and objectives. [FOOTNOTE 12] However, these arguments ultimately may be unconvincing since, after all, disclosure of additional non-EPS information could actually increase transparency, and there is evidence that eliminating earnings guidance does not increase short-term risk. A study of 4000 large companies between 1997 and 2004 "found no evidence that guidance affected valuation multiples, improved shareholder return, or reduced share price volatility. " [FOOTNOTE 13] The study found, by contrast, that companies expended considerable resources in preparing earnings guidance; moreover, the study found that the provision of earnings guidance actually served to increase tradi ng volume and attract "transient investors." [FOOTNOTE 14] There have also been reports that the costs and pressure of producing quarterly earnings estimates have contributed to companies' decisions to leave the public market altogether. [FOOTNOTE 15]

In the short term, companies may be correct to be wary of the negative stock price effect of eliminating quarterly guidance. A 2006 study examined 76 companies that announced during the period 2000-2004 that they were ceasing the practice of quarterly guidance and found a statistically significant loss in shareholder wealth during the three days immediately surrounding the announcements. [FOOTNOTE 16] Two commentators put it as follows: "To put their results in perspective, for a company with a $5 billion market cap, the elimination of guidance immediately destroys about $200 million in value, on average." These commentators examined 40 of the companies in the study that completely eliminated guidance and found that the stocks underperformed their industry benchmarks with a median annualized return of 10 percent as opposed to 17 percent. [FOOTNOTE 17] It is not clear whether this is because only companies that expected to underperform eliminated guidance, or because eliminating guidance caused investors to be wary. Either way, ceasing to provide guidance appears to be viewed negatively in the marketplace.

Another problem facing companies that wish to eliminate quarterly guidance or move to an annual guidance model is that analysts will continue to offer predictions, possibly less accurate, to eager investors. If these third-party predictions deviate significantly from a company's own internal forecasts, financial officers may feel the need, as a practical matter, to provide revised guidance or indications in order to better manage the expectations of Wall Street. This is especially true in the current environment where a penny or two missed in "consensus" EPS may result in millions or billions of dollars of market value evaporating. [FOOTNOTE 18]

Some companies have solved the problems of negative stock price effect and responding to analysts by providing detailed, value-driving information rather than EPS guidance alone. This type of information, such as operating statistics or cost estimates, can be provided frequently and, for the knowledgeable investor, can be more valuable than an EPS estimate. [FOOTNOTE 19] Alternatively, the practice of issuing annual rather than quarterly guidance may even be beneficial from a stock price perspective: [FOOTNOTE 20] One source found that, while companies that eliminated guidance altogether underperformed their industry benchmarks, companies that continued to give annual guidance outperformed their benchmarks by 25 percent versus 17 percent. [FOOTNOTE 21]

There appears to be a trend toward providing non-EPS estimates and annual forecasts rather than quarterly earnings guidance. The National Investor Relations Institute published a survey in June 2007 indicating that, of 752 respondents, 27 percent provided quarterly earnings guidance (down from 52 percent in 2006 and 61 percent in 2005) and 58 percent provided annual earnings guidance (up from 43 percent in 2006 and 28 percent in 2005). [FOOTNOTE 22] As a general matter, NIRI survey respondents who discontinued guidance in the last two years reported that sell side and buy side reactions were, on average, indifferent; that their stock price did not become more volatile; and that senior management was overwhelmingly pleased with the development.[FOOTNOTE 23]

In its thoughtful response to the Capital Markets Commission Report, the Disclosure Advisory Board argued that the recommendation regarding earnings guidance was unduly sweeping in proposing the permanent elimination of quarterly guidance, while, at the same time, too narrowly focused in its suggestion that companies alternatively should provide annual guidance with a range of EPS numbers. The Disclosure Advisory Board noted that many companies, such as those with no analyst coverage, properly use quarterly guidance to satisfy investor needs; the Disclosure Advisory Board argued further that annual EPS is too limited to be a meaningful benchmark and that guidance should consist of both short- and long-term guidance relating to qualitative and quantitative measures. [FOOTNOTE 24]

From the perspective of corporate governance best practices, management should review quarterly or annual EPS guidance with the audit committee before it is provided publicly. In addition, audit committees should work with management to consider whether to maintain or continue guidance practices in the current environment.

For many companies, the time has come to consider guidance in a more holistic sense. Companies should communicate with investors and analysts by providing information regarding performance, strategy, sustainability, risks, key developments, and other long-term variables and value drivers. Forecasts as to EPS numbers on a quarterly or annual basis may or may not fit into the disclosure model appropriate to a given company. The frequency and nature of disclosures are best determined on an individual basis, depending on the industry, the strategies involved and the demands of shareholders. Guidance along these lines is likely to flow more naturally from a company's internal forecasts and should require fewer resources to prepare. As the practice of quarterly earnings guidance falls out of favor, companies, analysts and investors can look toward a new era of meaningful disclosure, increased transparency, and improved communication.

David A. Katz is a partner at Wachtell, Lipton & Katz. Laura McIntosh is a consulting attorney for the firm. The opinions expressed are the authors' and do not necessarily represent the views of the partners or the firm as a whole.

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FN1 In July 2006, for example, the Business Roundtable Institute for Corporate Ethics and the CFA Centre for Financial Market Integrity released a joint report calling for the elimination of quarterly earnings guidance ("The obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns and impeding efforts to strengthen corporate governance." Breaking the Short-Term Cycle, Proceedings of the CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics, July 2006, at 1.).

FN2 Interestingly, companies seem to exceed the expectations of Wall Street at the same rate regardless of whether they issue earnings guidance. See Peter A. McKay, "Numbers Game: Why 'Guidance' May Not Matter," Wall St. J., July 23, 2007, at C1 ("Between 2001 and 2006, Standard & Poor's 500 companies that issued guidance beat analysts' expectations 65 percent of the time, while companies that didn't issue guidance beat them 63 percent of the time, according to a recent Thomson report.").

FN3 Report and Recommendations, Commission on the Regulation of U.S. Capital Markets in the 21st Century, Mar. 2007 (the "Capital Markets Commission Report") (the Capital Markets Commission is an independent, bipartisan commission established by the U.S. Chamber of Commerce).

FN4 Long-Term Value Creation: Guiding Principles for Corporations and Investors, The Aspen Institute, June 2007 (the "Aspen Principles") (signers and supporters include the Business Roundtable, the AFL-CIO, the Council of Institutional Investors, the five largest audit firms, and top executives at companies such as Pfizer and Xerox). See Francesco Guerrera, "Call for End to Corporate Guidance," FT.com, June 17, 2007.

FN5 See Built to Last: Focusing Corporations on Long-Term Performance, A Statement by the Research and Policy Committee of the Committee for Economic Development, 2007, at 24 ("CED Report"). The Private Securities Litigation Reform Act, enacted in 1995, created a safe harbor for companies to make certain forward-looking statements, including earnings guidance. With the Securities and Exchange Commission's adoption of Regulation FD in 2000, companies could no longer provide nonpublic guidance privately to analysts but generally were required to publicize any material information disclosed.

FN6 Daniel Vasella & Clifton Leaf, "Temptation Is All Around Us," Fortune, Nov. 18, 2002, at 109.

FN7 Capital Markets Commission Report at 7.

FN8 Id.

FN9 Aspen Principles.

FN10 See Sarah Johnson, "Kicking the Guidance Habit," CFO.com, Apr. 10, 2007.

FN11 See id. As the CED Report noted, "A key obstacle to change is the close link between short-term performance and incentive pay for company managers, fund managers, and analysts." CED Report at 25.

FN12 See Bambi Francisco, "Eliminate Quarterly Guidance?" Commentary, MarketWatch, Mar. 13, 2007.

FN13 CED Report at 24 (citing Hsieh, Koller, and Rajan, "The Misguided Practice of Earnings Guidance").

FN14 Id.

FN15 See id. (citing "Ownership Matters," The Economist, Mar. 9, 2006, at 10); see also Apples to Apples: A Template for Reporting Quarterly Earnings, CFA Centre for Financial Market Integrity & The Business Roundtable Institute for Corporate Ethics, Mar. 2007, at 3.

FN16 Shuping Chen, Dawn Matsumoto, & Shiva Rajgopal, "Is Silence Golden? An Empirical Analysis of Firms that Stop Giving Quarterly Earnings Guidance in the post Regulation FD Period," Oct. 2006 Draft, SSRN #820644.

FN17 See Vahan Janjigian & Michael Ozanian, "Gimme Guidance," Forbes.com, Aug. 22, 2006.

FN18 See, e.g., "The 'Numbers Game,'" Remarks by Chairman Arthur Levitt, Securities and Exchange Commission, N.Y.U. Center for Law and Business, New York, New York, Sept. 28, 1998.

FN19 See id. (describing successful implementation of this strategy by Progressive Insurance and coal producer and exporter Walter Industries).

FN20 It must be recognized that by providing annual guidance, a company is essentially proving quarterly guidance by the fourth quarter of the year and that, if annual guidance is updated on a quarterly basis, many of the same concerns with quarterly EPS guidance will continue to exist.

FN21 See Janjigian & Ozanian, supra.

FN22 National Investor Relations Institute 2007 Earnings Guidance Practices Survey Results ("NIRI 2007 Survey"); NIRI News Release, "Executive Alert: NIRI Issues 2006 Survey Results on Earnings Guidance Practices," Apr. 6, 2006.

FN23 NIRI 2007 Survey.

FN24 "Disclosure Advisory Board Responds to Chamber of Commerce Recommendations on Earnings Guidance," PR Newswire, Mar. 21, 2007, available at http://prnewswire.mediaroom.com.

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