11(a). Frequency of Interim Reporting

To the extent that earnings, earnings momentum and earnings potential drive the equity analytics of sell-side reports, the need for more frequent than annual information on performance is clear, as is the need for more finely disaggregated performance information, in common sized formats to enhance intercompany comparisons. [Also included in 1(a), 2(c), 3(c), and 3(d)] [PREVITS, p. 21]

__________

Frequency of Reporting

In the United States, publicly owned companies are required to report quarterly on Form 10-Q filings with the Securities and Exchange Commission. Exchange regulations require listed firms to send quarterly reports directly to shareholders. Private companies also tend to report quarterly to their creditors and other financial statement users. In most other countries financial reports are issued semi-annually; in a few countries, only annual reporting is the norm. Some people now advocate that the United States abolish its quarterly reporting requirement and regress to semi-annual or even annual reporting only. [Also included in 18(a)] [AIMR/FAPC92, p. 13]

The membership of AIMR unequivocally supports quarterly financial reporting and is absolutely opposed to any movement to eliminate it. Our arguments on that subject appear in more detail later in this report. At this point, we wish merely to point out that some of the impetus for the eradication of quarterly reporting results from the phenomenon of globalization. We believe that financial markets, both domestic and foreign, are best served by frequent and even-handed dissemination of information to the public. We urge the Congress of the United States, the SEC, and its international counterpart, IOSCO, to heed the admonitions later in this report on the subject of quarterly reporting. [Also included in 18(a)] [AIMR/FAPC92, p. 13]

Timeliness

Although Statement of Financial Accounting Concepts No. 2 categorizes timeliness as a subset of relevance, it has an importance to analysts that merits attention of its own. As we argue above, financial information is useful only when it is disseminated quickly, fairly and widely because the digestion of such information by analysts is what makes markets efficient. In the United States and Canada, this has been embodied in the practice of companies issuing financial statements quarterly supplemented by press releases and Form 8-K disclosures for important events occurring between reports. [AIMR/FAPC92, p. 22]

Recently there has been vocal criticism of the practice of quarterly financial reporting. It has been accused of causing managers of American businesses to focus on short-term results and of neglecting those activities whose worth would be greater over a longer time. Investors have been blamed for calling portfolio managers to account for their quarterly performances and portfolio managers for responding to them. [AIMR/FAPC92, p. 22]

Ironically, the financial markets are increasingly influenced by the investment activities of pension trusts, whose corporate sponsors are managed by the same persons who protest that frequent interim reports force them to manage for the short term. Also, it is unlikely that rational investors will punish a firm for undertaking projects that promise extraordinary long-term payoffs as long as that firm is willing and able to communicate to those investors its strategy and tactics. [AIMR/FAPC92, p. 22]

A further irony is that business managers themselves often are compensated or otherwise rewarded for short-term performance, measured either by accounting numbers or by the market performance of their employer's securities. Relief from so-called "short termism" is more likely to be successfully effected through changes in corporate governance, including fundamental and radical changes in the paradigm used to reward certain executives, than by abolishing one of the most important sources of analytic information available. [AIMR/FAPC92, p. 22]

A collateral benefit of frequent financial reporting is that it diminishes opportunities for trading on privileged information, a practice all responsible members of the investment community deplore. The longer a company waits to release information to the public the more likely it is that the information will become known sooner to a small and select group that can use it to trade for its own benefit. Even under current disclosure rules, which many find draconian, financial information has from time to time been intercepted or diverted on its way to dissemination. [AIMR/FAPC92, p. 23]

[Context] The following brief summary of the topic "Financial Statement Dissemination," is from the "Executive Summary" of the report the AIMR's Financial Accounting Policy Committee (FAPC):

In recent years mandated quarterly reporting in the United States has come under increasing attack. Many charges have been leveled, most recently that it leads to "short-termism" and that it causes the U.S. to lack competitiveness with the rest of the world, in which reports usually are issued only semi-annually. We feel strongly that these charges are wrong and this section provides an exposition of the virtues of quarterly reporting, refutation of the arguments against it, and an initial argument for disaggregated quarterly information (quarterly segment reporting). [AIMR/FAPC92, p. viii]

Obviously, financial markets and financial analysis thrive on information. Furthermore, information will eventually find its way to influence market prices, whether the avenues it takes are legitimate or not. As investment professionals who take pride in our ethical conduct, we need to have information that is frequent, reliable and relevant. We need to have it disseminated even-handedly so that it becomes available to all market participants at the same time, rather than first to the privileged few. We believe the arguments against quarterly reporting are specious and we give substantial reasons to support that opinion. [AIMR/FAPC92, p. viii]

[Context] It indicates the scope of the discussion of the topic and lists the report's major recommendations, providing an introduction to the following excerpts from the report.

Financial analysis thrives on information. There is an extended discussion earlier in this report of the various and sundry information sources employed by financial analysts and investment managers [included in 1(b)]. For capital allocation to proceed efficiently in our economy, information must be disseminated both promptly and publicly. This applies to financial information, both in the form of financial statements and otherwise, as well as to sources of all nonfinancial data that can affect perceptions of the value of companies. The two conditions, promptly and publicly, are complementary. As we explain below, if financial information is not disclosed to the public promptly it will become known first to a small number of privileged "insiders," only later filtering down to the public at large. Those circumstances place an onerous burden on AIMR members who are prohibited against the use of material nonpublic information by the AIMR Code of Ethics and Standards of Professional Conduct. [Footnote reference omitted.] [AIMR/FAPC92, p. 34]

The economic affairs of an enterprise should be reported in financial statement form at regular and frequent intervals. A year or six months is too long to wait for facts, either good or bad, to be disclosed formally. Less than three months is too short a period for most businesses to make meaningful measurements of economic activity; it also would require excessive periodic assessments of financial status. Thus quarterly interim reporting satisfies optimally the tradeoff between: (a) the maximum length of time an analyst should have to wait to receive a report on an enterprise's economic progress and status, versus (b) the minimum period of time for which meaningful financial measures can be made. [AIMR/FAPC92, p. 35]

Our comments on quarterly reporting herein have two different purposes. First, we wish to make clear and emphatic our unanimous opposition to recent movements by certain individuals and organizations to abolish mandatory quarterly reporting. Our case takes two forms: (a) substantiating the reasons why quarterly reports are vital to analysts and, perforce, for the efficient functioning of the capital markets; (b) showing why the arguments made for the eradication of mandated quarterly reporting are specious.11 Second, we wish to explicate how quarterly financial reporting needs to and should be improved. [Also included in 11(c)] [AIMR/FAPC92, p. 35]

Arguments Supporting Mandated Quarterly Reporting

The most overwhelmingly important ground for retaining quarterly reporting requirements is that alluded to above, the efficient allocation of capital within the economy. To repeat, financial analysis thrives on information. The more quickly it is made available, the faster investment decisions may be made to direct capital to uses that will overall maximize economic welfare. The ideal state is one in which economic events and their consequences are made public as they occur. In fact, most significant economic events become public knowledge before they are reported in financial statements. Their consequences however are a matter of speculation and disagreement among analysts, much of it reasonable and rational but speculation nonetheless, until financial statements are released. Until that time uncertainty exists, carrying with it a concomitant increase in capital cost. [AIMR/FAPC92, p. 35]

Most economic events affecting business enterprises are individually small in relation to the overall economic progress and status of the firm. But they aggregate into numbers of material size. Quarterly reports are the early warning system of the investment world. Some persons have likened them to the mile markers on superhighways. Even though they are not as precise in measurement as mile markers, they at least tell us in what direction the enterprise is going and roughly how quickly it is proceeding. [AIMR/FAPC92, p. 35]

To analysts quarterly reports are not only indicators of progress and status to date, they also are important resources for projecting the future. A good part of a financial analyst's work involves making recommendations or engaging in transactions based on expectations of future economic performance. Many analysts are called upon to make formal and frequent estimates of future corporate earnings. Quarterly reports are vital, not as much for what they tell us about the past as to what they tell us about revising our expectations of the future. When a quarterly report contains a "surprise," there usually is an immediate reaction in that enterprise's stock price. The stock price change reflects a change in value not because the past turned out differently than expected, but because the market has promptly and alertly changed its expectations of the future. [AIMR/FAPC92, p. 35-36]

Deterrence of trading on privileged information is the second major argument in favor of mandated quarterly reporting. As noted above, the code of ethics by which we work as professional analysts prohibits us from trading on material nonpublic information and we pride ourselves on our observance of it. Adherence to that code is facilitated by the frequency with which information is made public. If information is withheld from the public by law, it still will be disseminated. The process will be slower and it will trickle down to the public through a host of privileged insiders and other informed persons who realistically could not be expected to refrain totally from trading on what they know and others do not. Any attempt to abolish mandated quarterly reporting might better be termed an effort to promote insider trading. [AIMR/FAPC92, p. 36]

Quarterly reports may be even more important to individual investors than they are to investment professionals. We have a large variety of public sources of information and we rely on them to confirm in an organized manner, our judgments and the fragmentary data on which they are based. For individual investors, public reports may well be and usually are their only source of reliable information. Those who choose to invest in free enterprise should not be denied the information to make those investments in the wisest and best informed manner not only in their own self-interest, but also with the result of improving economic society as a whole. [AIMR/FAPC92, p. 36]

Rebuttal of Assertions Against Quarterly Reporting

Much has been written about the evils of "short-termism" and its impact on management behavior. It is true that sometimes too much emphasis is placed on quarterly earnings reports. It is remarkable that some seemingly sensible people will make decisions based on insignificant deviations from expected earnings. On the other hand, it is quite appropriate for decision makers to revise their forecasts of the future based on new and recent information about the past. The point is that stock prices reflect expectations of the future only, and that past events do not change stock prices as such; they only change expectations. Too many companies have explicitly or implicitly promised consistent quarterly earnings gains; in return they have received premium price-earnings ratios. The need to achieve target earnings may result in inefficient management practices; in extreme cases it can result in accounting manipulation or even fraud. As long as a business enterprise keeps its investors informed of its strategies and plans, it has no reason to fear that its share price will suffer for devoting its resources to projects that promise high levels of long-term profitability. Those who contend otherwise either misunderstand or are misrepresenting the functioning of the investment community. [AIMR/FAPC92, p. 36]

Investors are not only every bit as interested in long-term results as business managers are, but probably even more so. Consider the respective sources of rewards to investment managers and business managements. Investment managers are rewarded for overall performance of investments vis-a-vis the market as a whole. Stock prices, as we have explained at length several places above, are a direct function of expectations of long-run future cash flows. Stock prices do not change because of quarterly past events; they change because of changes in long-run expectations of future events. By contrast, consider how many senior managers are compensated or otherwise rewarded for short-term performance, frequently measured by accounting numbers. [AIMR/FAPC92, p. 36-37]

As we stated earlier, "short termism" might better be dealt with by changes in the manner of corporate governance and executive compensation schemes, rather than by eradicating quarterly financial reporting, one of the most vital ingredients in rational and efficient capital allocation. Our system of continuous disclosure helps make markets efficient. Annual earnings have been shown to have limited effect on market prices; three quarterly earnings reports have taken much of the surprise element out. Reduced frequency of reporting would be likely to increase the volatility of securities prices around the time of earnings reports. [AIMR/FAPC92, p. 37]

Another argument against quarterly reporting is that in most other countries only semi-annual reports are required or traditional. Some persons believe that reporting requirements in the United States, of which mandated quarterly filings are only one, prevent foreign companies from listing their shares on exchanges here. They prophesy that the United States has been and will continue to lose stature among the world's capital markets. [AIMR/FAPC92, p. 37]

We disagree. No foreign company is prevented by quarterly reporting requirements from listing its shares here, although some may elect not to do so. Many foreign companies are registered in the United States and we cite, from among European companies, the exemplary conduct of Royal Dutch Petroleum Company. It has an active financial relations program in the United States and its quarterly earnings releases contain detail far beyond British, Dutch, IASC or even U.S. requirements. As long as capital exists those who need it will seek it out. [AIMR/FAPC92, p. 37]

The United States has the most highly developed and sophisticated systems of capital market regulation in the world. The Securities and Exchange Commission has an admirable record in endeavoring to protect investors, not from the consequences of their own actions, but from those who would take unfair advantage of them. The disclosure rules in general, and mandated quarterly reporting in particular, are an integral part of the system to protect investors and the free enterprise system itself. We must be vigilant against those who would subvert that system into promotion of particular market places. Markets exist to serve investors, not the reverse! [AIMR/FAPC92, p. 37]

Quarterly Segment Reporting (QSR)

The topic of disaggregation is sufficiently important to merit its own separate discussion in the next part of this report. Here we wish to discuss only the need for disaggregated information to be provided more frequently than it is currently. Quarterly segment reporting (QSR) is a topic that has been advocated by analysts so consistently and so avidly over so many years that it has acquired its own acronym. In 1990, the AIMR Financial Accounting Policy Committee surveyed member analysts in the United States and Canada who responded overwhelmingly in favor of mandated quarterly segment reporting.12 Not only do analysts need financial reports as frequently as every three months, they need them in vastly more detail than is mandated today. Some companies do an excellent job in presenting segment data; others offer only the bare minimum disclosures required. We seek a much higher standard to apply to the latter. [Also included in 3(d)] [AIMR/FAPC92, p. 37-38]

It is the unusual publicly-owned company that today operates with a single line of business or in a single geographical area. All others requires analysis of their separate parts before an assessment can be made of their value as a whole. It is absolutely necessary for analysts not to have to wait for a full year to discover, for example, that a manufacturer of heavy equipment suffered major losses in Latin America earlier in the year. Or, that a manufacturing operation has been losing money, a fact concealed by the excessively good results of its finance operations. These data must be made available more frequently than is required now. [Also included in 3(d)] [AIMR/FAPC92, p. 38]

[Context] The AIMR report's introduction to the section entitled "Summary of Important Positions and Guide to Future Actions" begins and ends as follows:

Much of this report relates to the present state of the art and implications for future developments in financial reporting. Righfully, so do most of the positions stated in this section . . . [T]hey all build on positions taken by AIMR in the past . . . [Also included in 1(b), 1(d), 3(d), 4, 5(a), 8(c), 12, 18(a), 18(c) and 18(d)] [AIMR/FAPC92, p. 59]

We expect the positions set forth below to build on the precedents of the past. That does not prevent them from breaking new ground, but they do not introduce significant inconsistencies with previous AIMR positions. To the extent that they do establish new stances those are largely the result of the changing world that we describe earlier in this report. [Also included in 1(b), 1(d), 3(d), 4, 5(a), 8(c), 12, 18(a), 18(c) and 18(d)] [AIMR/FAPC92, p. 60]

Those two paragraphs introduce the following summary of a position taken by the Committee.

Provide Frequent and Detailed Financial Reports

Interim financial reporting requirements in this country have been the subject of much unjust criticism. They have been blamed for everything from "short termism" to a degradation in U.S. competitiveness. Not only are those charges without merit, they also fail to credit interim reporting for its vital role in keeping investors informed, diminishing opportunities for trading on privileged information, and maintaining peak efficiency of the financial markets. We believe we present in this report and elsewhere27 valid reasons to continue mandated quarterly financial reporting. [Also included in 1(d) and 3(d)] [AIMR/FAPC92, p. 63]

One of the primary deficiencies in contemporary financial reports is the minuscule amount of disaggregated data. In annual reports, that which is provided usually is skimpy and many firms have interpreted the provisions of FAS 14 so as to report fewer segments than an analyst might expect, and sometimes segments are defined by the firm in peculiar ways. Not only are we in urgent need of new definitions and disclosure requirements to emanate from the newly-inaugurated FASB project on disaggregation, we also need segment reporting extended to interim reports. Analysis of a complex enterprise with diverse operations is futile in the absence of significant quantities of disaggregated financial data. [Also included in 1(d) and 3(d)] [AIMR/FAPC92, p. 63]

__________

[Context] Meeting of the Investor Discussion Group on October 16, 1992. When discussing the types of information they use to achieve their objectives, a comment was made on the frequency of interim reporting.

Participant I-2

I used a similar concept, "normalized earnings" on a quarterly basis. For example, for [name deleted], I take out the $280 million pension credit, I take out foreign exchange gains and losses, and I normalize the tax rate. You have to be careful not to confuse people too much because you can normalize things so much that they won't have any idea of what you are talking about. But you have to normalize on a quarterly basis. Other adjustments are gains and losses on asset sales and insurance settlements, etc. [Also included in 1(b) and 5(a)] [TI 10/16, p. 39]

[Context] Meeting of the Investor Discussion Group on March 17, 1993. Part of the meeting was devoted to the topic of interim reporting.

Committee/Staff/Observer

Other questions on interim reporting. May we safely conclude that you prefer quarterly reporting as opposed to monthly or semi-annually? Also, may we conclude that you prefer full interim financial statements as opposed to just disclosure of summarized interim data? [Also included in 11(c)] [TI 3/17, p. 36]

Participant I-11

I'd say yes to both. [Participant I-12] touched on a key element. The greatest opportunities for inappropriate valuations to occur in stocks is when there's a change of direction in the company's business. We all spend a lot of our time trying to identify times when a company's business is changing direction. It's a balancing act because there's a lot of static in the data. It seems to me that the quarterly financial report is a pretty good filter for that. If you get much shorter than a quarter, there's too much static. If you get much longer than a quarter, it's too late. Also, we all want full financial statements instead of summary information. [Also included in 11(c)] [TI 3/17, p. 36-37]

Participant I-7

Most of my manufacturing companies would say that 60% of their earnings would come in the third month of the quarter. So the first two months are useless. [TI 3/17, p. 37]

Participant I-12

I'd have a heart attack if I had to go through quarterly earnings on a monthly basis. [TI 3/17, p. 37]

[Context] Meeting of the Creditor Discussion Group on March 11, 1993. Part of the meeting was devoted to the topic of interim reporting.

Committee/Staff/Observer

Question 11 deals with interim reporting. We presume that currently people prefer quarterly reporting as opposed to a move to more frequent reporting such as monthly. And we also presume that they prefer summarized information than the more detailed information, such as in the annual report. Those are items A and B on page 13 of the meeting materials. If someone has a belief that we have gotten that wrong from previous discussions, this would be a great time to register your complaint. [Also included in 11(c)] [TC 3/11, p. 46]

Participant C-13

It is of course common practice in many industries to report some items on a monthly basis -- sales, shipments, unit volume. Retailers come to mind particularly and automobile manufacturers. That's obviously useful disclosure and it's not a financial statement in any sense. But I wouldn't want any conclusion that the Committee comes to suggest that that's not an appropriate disclosure. [TC 3/11, p. 47]

__________

Participant C-11

I think the most valuable starting point is quarterly. And then you can think about twelve months or something. But, quarterly is where you get your exceptions, your change in trend, your seasonality and so on. [Also included in 11(b)] [TC 3/11, p. 48]

Committee/Staff/Observer

I wanted to follow up on the quarterly notion. How far do you extend that? If the quarterly information is the most valuable of what you get, would monthly be more valuable? And if not, why is quarterly more valuable than annual? I'm trying to understand what's the magic about some three month period. [TC 3/11, p. 49]

Participant C-5

Could you imagine twelve month end sales rushes or volume rushes? Right now business runs on four quarter end volume rushes. [TC 3/11, p. 49]

Participant C-13

Our conclusion is that the best cost/benefit trade off from our point of view is quarterly. After all, we're the owners of the business, ultimately we're paying these costs. [TC 3/11, p. 49]

Participant C-11

I'll try to answer the question. The trend aspect is definitely important. And it's not just looking at an individual company and other similar companies but also with economic activity in general. And there are enough changes that can go on during the year where even semiannually does not capture the movement and aggregate economics as well as individual company things. My own experience has been that the limited number of situations where I've had monthly data is that there is as much noise coming from the internal accounting of the company itself. Certainly companies that have larger size items that they're selling, one or two sales can have an impact. So the answer you would probably tell me is that I'm used to quarterly and that's why I like it but it does seem to fit as best as anything can the reporting of industry and aggregate information. [TC 3/11, p. 49]

Participant C-17

I think [participant C-11] just said it, that quarter is a period that's got a link where you can establish a trend, either from the prior quarter or within the quarter and annually. I think you're right, it's also something we have become accustomed to and have been used to doing. [TC 3/11, p. 50]

Participant C-2

I think just having the staff to process the information would put a strain on our organization but secondarily, if we feel that we need monthly statements because of a particular concern with some aspect of the credit, we will get them and use them. Otherwise, we feel like we can go from quarter to quarter and, in some instances, frankly, all we get are annuals, generally where we're well secured. [TC 3/11, p. 50]

[Context] Responses to the postmeeting questionnaire of the March 11, 1993 Creditor Discussion Group meeting.

QUESTION 15

b. Is the optimum interim period for financial reporting (Please choose ONE):

1 Monthly?

12 Quarterly?

0 Semiannually?

0 Other? Please describe: _

If other than quarterly, please explain why:

Participant C-14: But I believe there would be less securities price volatility and better creditor decisions if companies did report monthly revenue figures.

Participant C-21: Quarterly statements allow for too much time to go by without having any information. Again - size of company and loan would also dictate.

[PMQC 3/11, p. 23]

__________

[Context] For companies in the precious metals business, the Mining Industry Subcommittee of the AIMR Corporate Information Committee would like to see improvements in reporting the following:

Break-out of results for the seasonally important fourth quarter.

Annual and quarterly release of divisional operating results.

[Also included in 15] [AIMR/CIC91, p. 2]

__________

The following comment by [the] Chairman of the [CIC] Foreign-Based Oil Subcommittee, puts into good perspective many of the shortcomings overseas companies have in dealing with investors: "The committee felt that the area where there is most room for improvement was in the frequency and timing of interim reports and communications of business trends to investors on a timely basis. In general, quarterly/semi-annual/annual results are published much later than those of U.S. companies. The French practice, for example, is to release partial data on a timely basis (i.e. less than one month after a period's close), but not to release sector and financial details for one or even two months later. Without details, the initial release is of limited analytical value. . . . Most U.K. companies report semi-annual and do so quite awhile after the period has ended. Overall, these practices are in line with those of respective home markets but American investors, used to full detail within three to four weeks of the quarter's close, would prefer quicker and more detailed reports. [The Chairman] realize[s] there is a cost involved with doing this, but feels the market would be better informed and more efficient as a result. [Also included in 2(a), 15, and 16] [AIMR/CIC92, p. 3]

Most [CIC] subcommittees agree . . . [that] the following suggestion seems appropriate: [Also included in 1(b), 2(b), 2(c), 3(b), 3(d), 5(a), 5(d), 13, and 16(b)] [AIMR/CIC92, p. 3]

Quarterly reports with timely data presented in a format comparable to that of the annual report. [Also included in 1(b), 2(b), 2(c), and 16(b)] [AIMR/CIC92, p. 3]

__________

Reserves must be analyzed [according to Picoult[1],]. Insurance companies must set up various types of reserves, and analysts should be able to get those figures from the companies on a quarterly basis, although companies provide only annual data. [Also included in 1(b) and 1(c)] [AIMR FINSER INDUSTRY,

p. 97]

The FASB, the Securities and Exchange Commission (SEC) and other regulatory bodies are currently considering a requirement to prepare financial statements based on market values in place of financial statements prepared on a historical cost accounting basis. The questions in this section relate to this issue: [Also included in 1(b), 2(a), 2(b), 2(c), 4, 10(b), and 15] [KPMG BANK STUDY,

p. A-9]

Financial institutions generally release their results of operations and financial position two to three weeks after period end. If historical cost accounting was replaced with fair value accounting, it is expected that a financial institution's results of operations and financial position based on fair values would take more time to gather and not be released as soon. Indicate the amount of additional time delay that you would be willing to accept in order to obtain financial statements presented on a fair value basis of accounting.

58% Two weeks or less

18 Between 3 and 4 weeks

0 Between 5 and 6 weeks

0 Between 7 and 8 weeks

15 Other

9 No response

[Also included in 4 and 15] [KPMG BANK STUDY, p. A-15 ]

[One user commented fair] value accounting would make quarterly reports more difficult, but should not affect [the] timing of the annual report. [Also included in 4 and 15] [KPMG BANK STUDY, p. A-15 ]

_________________________________

[1] Myron M. Picoult, Managing Director, Senior Insurance Analyst, Oppenheimer & Company, Inc.