Dimon's Call to Scrap Guidance Raises Transparency Concerns
Corporate profits may be measly across the board, but at least when investors put money in a public company they think they know where it's headed.
So when a group led by JPMorgan Chase Chief Executive Jamie Dimon published a list of corporate governance principles last month, one in particular stood out: scrapping earnings guidance.
The proposal quickly drew support from bank CEOs, who criticized the seemingly never-ending cycle of providing — and meeting — 90-day targets. The heads of both BB&T and Fifth Third Bancorp said providing short-term forecasts diverts attention from long-term goals.
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But the call to scrap guidance — published smack dab in the middle of earnings season — has raised broader questions about corporate transparency. It comes as revenue growth at banks has been meager, as low rates weigh on margins.
As bankers line up in support, some experts have taken a more skeptical tone, saying the proposal may offer CEOs a way to dodge scrutiny about dismal performance, all in the name of good governance.
"Enough banks have performed poorly for a long time," said Mike Mayo, an analyst at CLSA, noting that the average bank stock is back to where it was two decades ago. "They should be on a short leash."
Mayo was quick to note that there are several exceptions — pointing in particular to the recent performance of JPMorgan. But he said guidance in general helps foster an open dialogue with investors about issues on the horizon.
If the industry faces problems similar to the recent oil crash, "are banks just going to stay mum?" Mayo said.
Dimon's governance initiative comes as hand-wringing over short-term, just-get-me-to-the-next-quarter thinking on Wall Street has recently come in vogue.
Hillary Clinton has breathed new life into the issue on the campaign trail. The Democratic presidential candidate has blasted what she calls the "tyranny of today's earnings report" to justify a range of economic policies, including overhauling the capital gains tax.
Other prominent executives and attorneys who represent management, including Martin Lipton at the law firm Wachtell, Lipton, Rosen & Katz, have called on the Securities and Exchange Commission to consider eliminating quarterly earnings reports altogether.
"That's the classic debate," said Jill Fisch, a co-director of the Institute for Law and Economics at the University of Pennsylvania, describing the longstanding trade-off between sacrificing short-term accounting goals for long-term economic value.
The Dimon group's recommendations — titled "Commonsense Corporate Governance Principles" — said public companies "should not feel obligated" to provide guidance, unless they believe doing so is beneficial to shareholders.
Members of the group included Berkshire Hathaway CEO Warren Buffett, who described guidance as promoting "corporate malpractice" in an interview with Bloomberg.
The CEOs of the investment firms BlackRock and Vanguard, Larry Fink and Bill McNabb, also took part. Meanwhile, Fidelity Investments walked away from the group in June, citing a concern about signing a blanket industry document, according to media reports.
Within the banking industry, there's no agreed-upon standard for earnings guidance. The information banks provide is mostly a mixed bag, according to equity analysts.
Most large and regional banks provide a smattering of forecasts on a handful metrics, such as fees, efficiency, loans or trading revenue.
Some small banks, including the $20 billion-asset Iberiabank in Lafayette, La., provide explicit earnings-per-share targets. Other companies, such as Wells Fargo, or the $9 billion-asset Glacier Bancorp in Billings, Mont., hardly provide guidance at all, analysts said.
"Everybody approaches it differently," said Emlen Harmon, an analyst at Jefferies.
While bankers vary in their approach, a number of big names are starting to embrace the idea of providing little — if any — at all.
"I've been trying to dislodge us from talking about efficiency ratios and things like that, because of exactly what Jamie and them are talking about," Kelly King, the CEO of the $222 billion-asset BB&T, said during the company's second-quarter call.
King described short-term guidance as a "trap," saying that it "just makes no sense." BB&T's efficiency ratio increased from the first quarter.
"You've got to deal with the short-term reality that people want to understand what's happening next quarter," Greg Carmichael, CEO at the $144 billion-asset Fifth Third, said in an interview.
Carmichael —who described guidance as a "constraint" — praised Dimon's push to do away with it. If the rest of the industry embraces the call, he will, too, he said.
Still, it is unlikely that guidance will go by the wayside anytime soon. It is simply in the interest of bankers to keep providing it, analysts said.
Eliminating guidance could make stock prices more volatile. Equity analysts, of course, use the commentary to create earnings models. Guidance helps to cut through the complexity of the banking industry and provide insight into what's on the minds of CEOs, analysts said.
But management arguably can use guidance to manipulate the market. In a study conducted by S&P Capital IQ of U.S. companies' earnings guidance between January 2003 and February 2015, about 70% of quarterly guidance fell below initial consensus estimates. Some observers have long wondered if companies keep estimates artificially low so that they can look better when actual results are reported.
"There is a perception that management uses guidance to 'walk down' market expectations going into an earnings season so that the company can beat analysts' consensus estimates when earnings are eventually released," wrote the authors of the S&P Capital IQ study.
During the second quarter, 14 of the 20 of the largest banks in the industry beat consensus estimates, according to Bloomberg.
"You don't want surprises — you want an orderly movement in the stock," said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. "It's the devil's choice."
For instance, Citigroup reported a 17% decline in profits last month. At a conference in June, CEO Michael Corbat said the bank was facing a tough quarter and provided guidance on net income, trading and investment banking revenue.
The company beat second-quarter estimates by 12%, a higher upside than nearly all of its largest rivals.
"Don't come out with two bad messages," said Harmon, describing the thinking behind the "age-old trick" of managing investor expectations. In other words, if your results are going to be poor, prevent the second bad headline that your stock is sagging.
Despite the skepticism, a number of investors and analysts were quick to say that they supported the efforts of Dimon's group.
"I agree with them," said Larry Seidman, a well-known activist investor. "I think doing away with that is good corporate governance."
Chris Marinac, an analyst at FIG Partners, said "management guidance is inherently incorrect."
"Sometimes the winds change and they cannot help that the Fed didn't raise interest rates," Marinac said. "It is very hard to predict how rates or spreads or pricing is going to act when the financial markets are inherently volatile."
Some of the best-managed companies do not get caught up in the quarterly frenzy and only provide information on long-term targets, according to Peyton Green, an analyst with Piper Jaffray.
It's often the right approach in an industry where short-term gains are rare. "It's a patient-investor's game, where you compound out relatively small returns," Green said.
There could be upsides for analysts, as well. Doing away with guidance would push them to fine-tune their economic models, rather than simply taking management forecasts at face value, Harmon said.
"On the positive side, it would require more independent thought on the part of analysts," he said.
But, ultimately, the plan will have to overcome the natural resistance in markets to any taking away of information.
Companies should continue to provide earnings guidance, if only because they have for years steadily decreased the amount of useful information they provide the market, said Baruch Lev, a New York University accounting professor and author of "The End of Accounting."
"If managers feel they are capable of doing this, who feel they have a better outlook and perception on their operations than investors, I don't see any reason for other people to tell them not to do it," he said. "It seems almost absurd to me."