The Pitfalls of Quarterly Capitalism

Creating the maximum possible shareholder value had always been the cornerstone of capitalism. All economic theories had always been aimed at maximizing long term shareholder value. However, in the late 90’s and early 2000’s, this situation changed rapidly. Instead of reporting annually, companies had to report their profits or losses on a quarterly basis. It is believed that such a reporting would provide the shareholders with more up to date information and enable better decision making. However, there were also side-effects to this phenomenon of quarterly reporting. The biggest side effect was the beginning of what is colloquially called as “quarterly capitalism”. In this article, we will understand what quarterly capitalism means and what its effects are.

The Meaning of Quarterly Capitalism

Quarterly capitalism refers to policies created with a short time frame in mind. The name is derived from the fact that most executives are unwilling to take decisions that hurt the company in the short run but benefit it in the long run. Hillary Clinton once famously mentioned in her speech that most executives believed that markets and activist shareholder groups would negatively affect them if they pursued policies that prioritized long term interests over quarterly benefits! This should send alarm bells ringing for any value investor who thinks and buys long term.

Factors That Led To the Rise of Quarterly Capitalism

Quarterly results have been a mere enabling factor in this trend. The following factors also played a significant role.

• Drop in CEO Tenure: The average CEO tenure is all the major companies have gone done from 8 years to 4 years. If the CEO is staying in the company for a shorter period, then the policies being implemented will also be myopic in nature. The success and failure of any CEO are known by the quarterly results that they produce. Hence to maintain the illusion of their success intact, CEO’s tend to focus a lot more on short term results than they otherwise would.

   

   

• Payoffs Linked to Quarterly Results: The top management executives in any corporation have a huge chunk of their compensation linked to the quarterly result. Taking a hit in the short term results means taking a hit in their immediate compensation. Better results might accrue over the long run. However, the management might have changed till then. It, therefore, makes no sense for the executives to devise and follow through with long term plans.

   

Effects of the Rise of Quarterly Capitalism

• Innovation Takes a Hit: Innovation and research are bound to take a hit when the focus is on obtaining short term results. Most research takes place over the long term. In the quarterly results, innovation may appear to be a needless expense that needs to be minimized. However, companies that spend generously on innovation and ensure that the money is well spent are the business leaders of tomorrow. With the advent of quarterly capitalism, innovation has been outsourced to startups or private companies in Silicon Valley. The larger corporations are no longer at the forefront of the technological revolution.

   

   

• Investments: Capital investments also need to be made with the long term in mind. 10 to 15 years is a pretty small time frame as far as mega decisions like building a factory or a plant are concerned. These decisions are semi-permanent in nature. Hence, if the quarterly obsession influences these decisions, the organization may not be able to make the most optimal use of their resources.

   

   

• Diversion of Resources: Quarterly reporting is a gigantic administrative task. Even with the advent of all sorts of technology, there is still a lot of work that needs to be done. Precious scarce resources are diverted towards regulatory and administrative tasks. Reporting less often is simply a more efficient way to do business.

   

   

• Increased Volatility: Quarterly reporting has started causing increased volatility in the system. Companies release guidance and targets every quarter. Based on whether or not such targets have been met, the price rises or drops. This puts immense pressure on the management to use any means necessary to protect their stock from market volatility. The culture of quarterly capitalism has also been blamed for being the enabler in many stock markets scams such as Enron and WorldCom.

   

An Alternate Solution: Semi-Annual Reporting

One possible solution to this problem is if the stock exchanges mandate that companies declare their results semi-annually instead of quarterly. This will help organizations maintain a slightly longer term focus and avoid some of the pitfalls mentioned in this article. However, the response is expected to be varied. Tech companies from Silicon Valley are unlikely to accept this mandate and so are other companies that are in the middle of a bull run. When a company is doing well, it needs every opportunity to broadcast its performance. Such public announcements have a positive effect on the company’s stock price and the promoter’s net worth. Mature companies like utility companies are likely to accept this mandate. Their reports are likely to be similar regardless of whether they are published quarterly or annually.