Knowledge is power: UBC study shows more frequent financial reporting helps investors

Every quarter, investors anxiously await reports from the companies they’ve bet on, hoping they’ll beat analyst estimates and carve a path to prosperity. 

But does reporting frequently lead companies and their shareholders to focus too much on short-term gains? Or does it assist investors in making better-informed decisions? According to a new study from the UBC Sauder School of Business, when companies report more often, investors can more accurately predict future earnings and determine a stock’s price. It can also lead companies to make additional voluntary disclosures. 

The frequency debate is one that reared up over the past decade, with critics arguing quarterly reporting can cause companies to focus too heavily on short-term gains, and shy away from important longer-term investments in things like research and development. Conversely, proponents believe less frequent reporting stops investors from identifying developments, trends and risks in a timely way. 

Public companies in the U.S. and Canada are required to file quarterly reports — but in 2013 the European Union removed its quarterly requirement, and in 2018 the U.S. Securities and Exchange Commission (SEC) nearly followed suit but ultimately stayed the course. 

In hopes of settling the debate, the researchers examined data from 1954 through 1972, when many U.S. companies switched from reporting once to twice a year, then to quarterly — some of them meeting SEC requirements and others acting voluntarily. 

The research team then paired companies that were transitioning to more frequent reports with ones that had already made the switch to quarterly reporting, and compared how well their current stock returns predicted their future performance.

What they found was that before the change, companies’ returns were 36 per cent less predictive of long-term future earnings than those in the control group. After the switch to more frequent reporting, that number dropped to seven per cent. 

In other words, when companies reported more often, investors could more accurately predict long-term future earnings, which helped them more accurately price investments.

“It provides strong evidence that it's only companies that increase their reporting frequency whose earnings are becoming more predictable,” says UBC Sauder Assistant Professor Dr. Jenna D’Adduzio, who co-authored the study with David S. Koo of George Mason University, Santhosh Ramalingegowda of University of Georgia, and Yong Yu of the University of Texas at Austin. “So that means that after they started reporting quarterly, investors were better able to predict the future earnings information relative to when the company was reporting on a semi-annual basis.”

The study shows the effect was especially pronounced in companies whose earnings are less consistent, or more seasonal.

“If they're only reporting once or twice a year, as opposed to four times a year, investors aren't going to be aware of how seasonal that earnings process is,” says Dr. D’Adduzio. “When there's more frequent reporting, that's going to give investors more information to better understand why the earnings are less persistent, and help them incorporate that into building their expectations for what future earnings will be.”

What’s more, the researchers found the firms that reported more often also tended to provide more voluntary disclosures such as earnings forecasts, because investors are looking for clues ahead of quarterly reports.

“When there’s an earnings announcement that's about to happen, investors always want to get that information sooner — and because they're demanding that information, managers are providing forecasts sooner and more often,” says Dr. D’Adduzio. “And when firms provide more forecasts, investors can better predict the future.”

The findings counter the notion that investors and managers are myopically focusing on short-term performance, at the expense of the longer-term health of the business. 

Dr. D’Adduzio points out that the study focuses on the link between the frequency of information and investors’ ability to predict performance — and doesn’t consider the potential downsides of more frequent reporting for companies, including increased costs. She also emphasizes that even with more frequent reporting investors can still be short-sighted and companies can feel the pressure to produce short-term results. 

The study is the first of its kind to look at how reporting frequency affects investors’ ability to predict future earnings, rather than focusing on how it affects managerial behaviours. 

“With this change in reporting frequency, investors are not short-sighted, which has always been the concern. They are able to use that information to help them think more specifically about a company's future,” says Dr. D’Adduzio. “They aren’t using it just to figure out if a company did well this quarter.”