Earnings Guidance: Meet, Beat or Delete?
The problem arising from lofty predictions is not just that they spread unwarranted optimism. Even more troublesome is the fact that they corrode CEO behavior. Over the years, Charlie [Munger, Berkshire's Vice Chairman] and I have observed many instances in which CEOs engaged in uneconomic operating maneuvers so that they could meet earnings targets they had announced. Worse still, after exhausting all that operating acrobatics would do, they sometimes played a wide variety of accounting games to "make the numbers." These accounting shenanigans have a way of snowballing: Once a company moves earnings from one period to another, operating shortfalls that occur thereafter require it to engage in further accounting maneuvers that must be even more "heroic." These can turn fudging into fraud. (More money, it has been noted, has been stolen with the point of a pen than at the point of a gun.)
Buffett didn't exactly predict the wave of corporate scandals that came in the years immediately after he wrote these words, but he sure wasn't surprised by it. He was prescient even if he wasn't prophetic.
The recent corporate scandals have produced a changed atmosphere and led to changed corporate practices, including changed practices regarding earnings guidance . A 2006 survey conducted by the National Investor Relations Institute found that fewer and fewer companies are providing quarterly earnings and revenue guidance. Among the survey's findings is that the number of companies providing earnings guidance declined to 66% from the 71% in the prior year's survey (and down from 79% in the 2001 survey), and that only 56% of companies provide revenue guidance, down from 60% in the prior year. The survey also found that only 52% of companies were providing quarterly earnings guidance, down from 61% in the prior year. Among the prominent public companies that are declining to provide guidance are: Coca-Cola, AT&T, McDonald's, Google, General Motors , Ford, Motorola, and Campbell Soup. A Wall Street Journal article discussing the 2006 NIRI survey appears here (via wsj.com, subscription required).
A thoughtful discussion of the issues surrounding earnings guidance appeared (via economist.com, subsciption required) in a recent issue of The Economist magazine. Among other things, the article presents data from an academic study showing that companies that actively guided met or beat analysts' estimate more often that occasional or nonguiders, but that the active guiders grew more slowly than occasional or nonguiders. On the other hand, the article quoted a different academic study analyzing 76 companies that have ended quarterly guidance since 2000 and concluded that poor performers were more likely to reduce guidance, suggesting that "ending guidance can be a fig leaf for companies in trouble." (While that certainly can't be said of Berkshire or Google, it might be an accurate statement about GM or Ford).
One thing is for sure; more and more companies are deciding that the best way to avoid missing guidance is to avoid giving guidance. A detailed discussion of the pitfalls of earning guidance and analyst communications -- and how to avoid them -- can be found here.
A May 4, 2006 article on CFO.com reports that a former accountant for a heart-disease research foundation was sentenced to two to six years in prison for embezzling more than $237,000 from the foundation. The accountant apparently used the embezzled funds to pay for the services of Lady Sage, a dominatrix. He also allegedly charged purchases at stores such as Leather Creations, Victoria's Secret and Wicked Naughty Accessories. His attorney told the press that "It's just one of those things. I guess it was a midlife crisis." Apparently that explanation did not satisfy the accountant's wife, who, according to the article, "was so angry that she refused to pay for [his] $10,000 bail."