Quitting the guidance game: why are more CEOs keeping silent on earnings?

Chief Executive, The, June, 2005 by Joan Warner

Damned if we do, and damned if we don't" fairly sums up the way CEOs and their financial deputies feel these days when it comes to giving future earnings guidance.

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On the one hand, investors and analysts pressure executives for a specific, regular profit estimate, and unless the company meets or beats that number, millions of dollars' worth of market capitalization can vaporize in minutes. On the other hand, intense scrutiny of corporate auditing and accounting procedures has made some time-honored methods of bolstering current earnings statements dicey at best. Scrambling to make short-term numbers, managers make short-term decisions that delay important investments in R & D or marketing. And in today's regulatory environment, CEOs and CFOs get punished if they don't announce every bit of news--even the good news--as soon as they know it and as publicly as possible.

Caught between the proverbial rock and hard place, CEOs are hunkering down with their boards and advisors to figure out the new rules to the earnings guidance game--if, indeed, there are any clear rules. In fact, the issue of how best to share critical information with the public is such a hot button that when Chief Executive asked to speak with corporate officers, auditors and investor relations pros, nearly all declined. "People are lying low on this issue because they're not sure what to do," says Louis M. Thompson, president of the National Investor Relations Institute (NIRI) in Vienna, Va., who has attended long, tense conclaves on the subject with his association's beleaguered members.

The fear and confusion surrounding earnings predictions speaks volumes about a corporate climate that's full of uncertainty. Haunting every decision about what the market needs to know is the still-amorphous specter of Sarbanes-Oxley, which makes CEOs and CFOs personally accountable for the veracity of financial statements. Then there's the Securities and Exchange Commission's Regulation FD (for "fair disclosure"), which states that companies can't share "material news" selectively--that is, with a small group of analysts or institutional investors. Yet the pressure to deliver smooth earnings, and to minimize stock-price volatility, hasn't let up.

No matter what a CEO does, it doesn't seem to be right. Look at General Motors. In mid-April, the company announced its biggest quarterly loss in 13 years. The $1.1 billion hit, due mainly to a steep drop in the carmaker's North American business, worked out to $1.48 per share. That was actually a couple of cents better than what the company had estimated when giving guidance to Wall Street the previous month; by the time the audited numbers were announced, investors had already priced them into GM's shares. So, what did CEO Rick Wagoner do to spark April's stock dump? He decided to hold off on giving guidance for full-year 2005 results, pending the outcome of a United Automobile Workers' union negotiation over health care benefits. Investors figured that could only mean more bad news.

In another cautionary tale, the SEC recently fined Flowserve, a global pump and valve maker based in Irving, Tex., $350,000 for affirming its earnings guidance at a private meeting with analysts, just one month after the company had issued the same affirmation publicly via a Form 10-Q. Flowserve's CEO was personally fined $50,000 for answering an analyst's question at the meeting, and its IR director got a cease-and-desist order. The case marked the first time the SEC had ruled that simply confirming, rather than revising, earnings guidance amounted to "material news"--the CEO ran afoul of Reg FD by saying nothing had changed--and the first time an IR professional was included in the enforcement action, for not stepping in.

Two recent studies suggest that, thanks to nervousness over compliance, more companies are backing off from giving any guidance at all, or giving it less frequently. In an annual survey of finance executives at major U.S. corporations by Greenwich Associates, 55 percent of the 385 respondents said they had issued some form of earnings guidance during 2004, down from 72 percent in 2003.

And when the National Investor Relations Institute questioned 527 of its corporate members on their guidance practices, two results jumped out. The number of companies providing only annualized guidance nearly doubled, from 16 percent in 2003 to 28 percent last year. Those giving quarterly guidance (either exclusively or in addition to annual estimates) fell sharply, from 75 percent to 61 percent. "Everybody's afraid," says Frank Redican, a veteran of brokerage house Josephthal & Co. in New York who now runs his own investment firm. "Sarbanes-Oxley changed something, but I'm not sure what."

From Nothing to Everything

Theoretically, the point of all the new regulation is twofold: to protect investors from behind-the-scenes activities that could affect the value of their holdings, and to encourage companies to manage for long-term growth rather than short-term profitability. How to accomplish these worthy goals has been debated for decades. In the early days of securities regulation, the SEC didn't permit companies to make earnings forecasts at all. Management released audited and unaudited financial statements as they were compiled. While analysts could publish whatever predictive opinions they liked, estimates from management were considered confusing and counterproductive.