To Guide or Not to Guide: A Look at Earnings Guidance

Investors' reactions to earnings announcements are another gauge of the change in the information environment. Other things being equal, the richer a firm's information environment before an earnings announcement, the weaker the investors' reaction to reported earnings should be. So we examined whether the guidance stoppers' earnings-returns relation was different in the post-event period than in the pre-event period. The data indicated that investors responded more strongly to earnings announcements after firms stop guidance, which is evidence of a relatively poor information environment post guidance cessation.

Correcting Myopia?

Guidance stoppers and their supporters frequently claim that after guidance cessation, firms provide substitute disclosures about strategy and long-term objectives to mitigate investor myopia. We examine this assertion empirically by collecting and coding stoppers' forward-looking disclosures in quarterly earnings press releases and in the Management, Discussion & Analysis (MD&A) section of the quarterly reports.

We randomly chose 100 stoppers from our stopper sample, and, for each stopper, we randomly chose a fiscal quarter in the post-event period, which we referred to as the "post-quarter." We looked at forward-looking, non-earnings disclosures in nine categories and compared the number of disclosures in the pre- vs. post-quarter. The data show that more stoppers decreased forward-looking disclosures than those that increased disclosures: 41 decreased, 29 had no change, and 27 increased. We also found that stoppers curtailed their annual guidance.

Finally, we looked into a major argument of guidance detractors: quarterly guidance focuses managers' attention and decisions on the short-term at the expense of long-term growth. Regulators and trade associations have similarly expressed concerns that quarterly earnings guidance has contributed to managers' myopia. If quarterly guidance indeed increases managers' myopia at the expense of the firm's long-run growth, we should observe an increase in long-term investments, such as capital expenditures and research and development (R&D), once firms stop quarterly guidance and managers are unshackled by the myopic earnings game. To test this assertion, we measured long-term investments by both capital expenditures and R&D intensities -- i.e., deflating the expenditures by the beginning-of-quarter total assets.

Because a firm's long-term investments are likely to vary across industries, we adjusted capital expenditures and R&D in each quarter by the median levels of these investments in a firm's industry. We found that guidance stoppers do not increase their long-term investments after the guidance cessation. This finding, however, may not be generalized to the population of firms not providing guidance. Recall that guidance stoppers are characterized by relatively poor earnings performance in the pre-guidance cessation period and anticipate continuation of poor performance after stopping guidance. Accordingly, the long-term investment opportunities and decisions of these firms may be different from those of the general population of non-guiders.

Next, we considered the flipside of this issue and examined the stoppers that subsequently resumed providing guidance. Among our 222 guidance stoppers, a full 68 firms (30.6 percent) resumed quarterly guidance, according to either the CIG database or our news search in Factiva. The median length of the silent period was six quarters -- a relatively short time for a reversal of a significant change in disclosure policy. To analyze the determinants of guidance resumption, we used a sample of 42 firms as our resumer sample. We found that relative to the non-resumers, the resumers experienced (weakly) a larger decrease in analyst following, a smaller increase in forecast dispersion, a decreasing percentage of loss quarters, and improved earnings in the silent period. Thus, firms that resumed quarterly guidance were by and large affected more severely by the stopping decision.

The debate on guidance is clearly continuing. In June [2007], a coalition of labor unions and CEOs, led by the Aspen Institute, issued a plea for companies to cease giving quarterly guidance. But our investigations show that the concerns surrounding guidance aren't necessarily borne out by activity in the marketplace. Critics may think that guidance has a pernicious influence on the public capital markets -- one that harms investors, doesn't help analysts, and pushes managers into self-defeating, myopic actions. The data tell us otherwise.