QUARTERLY REPORTING: GOOD CORPORATE GOVERNANCE OR AN OBLIGATION OF LITTLE VALUE?
Many international listed entities operate in a business environment that demands increased transparency through corporate disclosure. Quarterly reporting has been identified as a tool that may meaningfully enhance transparency through more frequent public disclosure. However, the question as to whether quarterly reporting is beneficial has no simple answer, as empirical evidence suggests that quarterly reports may not have the perceived benefits for transparency and good corporate governance.
Although South Africa has kept pace with international trends and standards of financial reporting, there is unfortunately no international standard practice when it comes to quarterly reporting. Listed entities in a number of countries, including the United States of America, Canada and Brazil report quarterly as they are required to do so by their respective stock exchanges; listed entities in Great Britain*, Australia and New Zealand report on a half yearly basis.
The European Union has attempted to standardise periodic reporting requirements by issuing the European Union Transparency Directive in July 2007. This Directive promotes half yearly reports combined with Interim Management Statements issued between reporting dates. However, the implementation of the Directive among the member states has been slow and harmonisation is still a distant goal.
Simplistically, the proponents of quarterly reporting suggest that more frequent disclosure of financial information is of benefit to investors as it provides a more frequent, timely and transparent representation of the financial position of the entity. They believe that, in a constantly evolving economy, these disclosures will lead to better investment decisions and fairer access to information for all stakeholders. Its opponents believe that quarterly reporting leads to the distortion of the long-term financial positions and share prices of reporting entities. A more detailed list of the arguments for and against quarterly reporting is presented below.
- More frequent reports result in share prices that reflect the latest financial position of the entity.
- Reporting is no longer only an organ solely for investors. Increased disclosure will benefit other stakeholders (e.g. major suppliers) in the entity, increasing the entity’s transparency.
- Quarterly reporting will reduce the disparity in access to information between minority and controlling shareholders by providing the former with increased and more timely information.
- Reporting on a quarterly basis requires that the management of an entity frequently review and assess financial performance and internal control systems.
- Quarterly reports are likely to be unreliable predictors of full year results as they fail to take into account seasonal variations. The average user is unlikely to be able effectively to adjust for seasonal variations when performing analysis.
- The allocation of period costs will be difficult for quarterly reports.
- Quarterly reporting is misleading due to the inaccuracy that surrounds setting of estimates and provisions. Where extensive estimates and provisions must be set, aggressive (manipulative) reporting, which can distort quarterly figures, is facilitated.
- Quarterly reporting promotes a short-term view of the entity, leading to an overemphasis of the detail of the report, rather than a balanced view of the actual financial position and long-term prospects of an entity.
- The cost and time involved in preparing quarterly reports outweigh the benefits of the information being disclosed. This relates particularly to entities that must incur costs in making estimates, provisions and obtaining fair values.
- A quarter does not provide a long enough period to draw a conclusion about the entity’s financial position. The shorter period will result in an unusual (isolated/one-off) event having a much greater effect on the results than if viewed in relation to the results over a longer period.
While the arguments both for and against quarterly reporting warrant consideration and discussion, empirical studies indicate that there are three particularly important issues surrounding quarterly reporting. These are share price volatility, the timing of the release of the report and independent evaluation of the report.
Volatility of Share Prices
Opponents of quarterly reporting suggest that quarterly reporting promotes share price volatility because the information disclosed does not properly reflect the business cycles that affect the entity. Mensah and Werner (2006) show that increased reporting frequencies lead to increased stock market volatility. The study evaluated samples of listed entities that reported on a quarterly basis (United States of America and Canada) and entities that reported on a half-yearly basis (Australia and Great Britain).
Both proponents and opponents interpret this finding to support their standpoints. The proponents maintain that stock price volatility, resulting from quarterly reporting, is a true reflection of the latest financial position of an entity. Opponents maintain that the volatility is brought about by inaccurate and incomplete information being disclosed.
Mensah and Werner (2006) suggest that volatility arises because quarterly reporting requires that extensive estimates be made, resulting in inaccuracies, to which investors respond. It is suggested that because entities that report quarterly are aware of the increased volatility of the share price, the problem of earnings management, through the manipulation of estimates, becomes more prevalent. This can be compounded by the pressure of an expectant market. Through no fault of their own, entities with longer business cycles may be unintentionally misrepresenting their true financial position by having to report on a quarterly basis.
Independent Evaluation of Reports
While quarterly reports do provide information on a more frequent basis, the question arises as to whether reports that are not subjected to an independent audit or review are of any real value.
It is obvious that the sum of all reported quarters must equal the final result for the year. A study by Manry, Tiras and Wheatley (1999) revealed that entities with timely quarterly reviews** showed less evidence of smoothing (manipulating results in order to ensure that the reported quarters results equal the audited final result) in the 4th quarter than those with retrospective reviews. This suggests that timely review of quarterly results enhances the accuracy (and thus usefulness) of information presented. Similarly, Etteredge, et al. (1999), reflected that entities with timely reviewed reports had a lower frequency of 4th quarter adjustments than those with retrospective reviews.
Haw, Qi and Wu (2003), in their study on Chinese interim reporting, reflected that entities that elected to have interim data audited/reviewed (interim audit/review is not compulsory in China), did so in order to enhance the credibility of the information reported. Based on the evidence presented it would appear that independent evaluation of quarterly reports by review or audit greatly enhances the accuracy and usefulness of the reports.
Timing of the Release of the Report
Opponents of quarterly reporting question whether quarterly reports can be issued timeously enough to be of any value to users. By the time the quarterly report is released, the entity will be well into its next quarter, and information being released may have become “old news”. There is also the question of speed of issue versus accuracy of information.
Mensah and Werner (2006), citing Lambert and Roy (1991), indicate that countries following a quarterly reporting regime are more concerned about the timeliness (speed of issue) of information release, while half-yearly reporters are more interested in the accuracy of the information provided. It is also perceived by users that quarterly reporting inevitably results in inaccuracies, which contribute to share price volatility as discussed above.
It is interesting to note that Boritz and Liu (2006) found evidence that entities with a higher level of information transparency released interim reports more timeously than those with lower levels of information transparency. This study does not relate directly to quarterly reporting. However, it seems logical that entities with good corporate governance policies and procedures (a high level of information transparency), would be in a better position to issue meaningful and accurate quarterly reports more timeously.
Boritz and Liu (2006) also found that independently reviewed interim reports were released more timeously than those that were not reviewed. They suggest that this is due to a perceived negative opinion that the market has for non-reviewed reports, resulting in those entities issuing non-reviewed reports delaying release until the last minute.
An Alternative to Quarterly Reporting
Voluntary disclosure by entities is often a good indicator of commitment to transparency, which is what quarterly reporting seeks to achieve. However, Gigler and Hemmer (1998, 2001) as cited in Butler, Kraft and Weiss (2006) suggest that an increased frequency in mandatory reporting decreases the number of voluntary disclosures made by entities. They suggest that the reasons for this may be the increased cost of multiple disclosures, and the decrease in the value of information contained in voluntary disclosures. Thus mandatory quarterly reporting may be counter productive. Perhaps what is required instead of mandatory quarterly reporting is a method of disseminating voluntary information to all stakeholders in a cost-efficient manner. Web-based disclosure platforms can provide such a method.
This contention is supported by Debraceny and Rahman (2005), as cited in Rahman et al (2007) in their study of online reporting in Singapore. They reflected that online reporting provided opportunities to disclose relevant information at low cost on a continuous basis, and also provided all stakeholders with easy access, low cost information searches and up-to-date data. However, despite the advantages of online reporting, the issues of share price volatility and the lack of independent review of the information disclosed remain.
As illustrated, mandatory quarterly reporting does not necessarily contribute to improved corporate governance. Although disclosure frequency is increased, the resulting problems may outweigh the benefits. Perhaps voluntary independently reviewed disclosures to all stakeholders would be of greater value.
*Explanatory note: Great Britain has since adopted the European Union Transparency Directive.
**Explanatory note: The SEC requires listed entities to have what is referred to as a timely review of interim reports. This means that the review must be carried out at the time of reporting. Previously, a choice between a retrospective review (a review of interim reports at year end) and the timely review was allowed.
- Boritz, J.E and Liu, G. 2006. Determinants of the timeliness of quarterly reporting: Evidence from Canadian Firms.
- Butler, M., Kraft, A. and Weiss, I.S. 2006. The effect of reporting frequency on the timeliness of earnings: The cases of voluntary and mandatory interim reports.
- Etteredge, M.L., Simon, D.T., Smith, D.B. and Stone, M.S. 1999. The effect of the external accountants review on timing of adjustments to quarterly earnings.
- Haw, I., Qi, D. and Wu, W. 2003. The market consequences of voluntary auditing: evidence from interim reports in China.
- Manry, D., Tiras, S.L. and Wheatley, C.M. 1999. The influnece of timely reviews on the credibility of quarterly earnings.
- Mensah, Y.M. and Werner, R. September 2006. The Capital Market Implications of the Frequency of Interim Financial Reporting: An International Analysis.
- Rahman, A.R., Tay, T.M., Ong, B.T. and Cai, S. 2007. Quarterly Reporting in a voluntary disclosure environment: Its benefits, drawbacks and determinants.
- The EU Transparency Directive. July 2007. Periodic reporting requirements.
Rowan Jackson, BCom (Hons), is a senior auditor at Deloitte.