Should mandatory quarterly reporting be scrapped?
As regulators worldwide contemplate the necessity of mandatory quarterly reporting, it is important to consider the potential impact on investor confidence and firm value
There is an ongoing global debate about the pros and cons of mandatory quarterly reporting. In Australia, ASX-listed companies must report their financial results to shareholders at least twice a year, within two months of the end of their balance sheet date. The primary reporting season is August when most companies release full-year results. But in the US and some other countries, companies must provide quarterly and full-year statements. In contrast, the EU has stopped mandating quarterly reporting, and Singapore also reduced the requirement for mandatory quarterly reporting to certain high-risk firms only.
So what exactly is the cost-benefit trade-off of mandatory quarterly reporting? Should mandatory quarterly reporting be scrapped? Some past studies have shown that mandatory quarterly reporting can lead to short-termism. The question is, do these costs outweigh the benefits? A recent UNSW Business School study looks closely at investor behaviour during this period and provides new evidence to the debate about whether all mandatory quarterly reporting should be scrapped.
Is mandatory quarterly reporting worth it?
To answer this important question, Yuchen Zhang, a doctoral candidate and PhD Teaching Fellow in the School of Accounting, Auditing & Taxation at UNSW Business School, analyses the changes in the enforcement of Quarterly Interim Management Statements (IMS) in the UK. In 2004, UK public companies were required to issue quarterly IMS in addition to the semiannual financial reports. While this was reverted to voluntary in 2014, this period provides an opportunity to test the cost-benefit effects of mandatory quarterly reporting and whether regulators should impose mandatory quarterly reporting in the future.
Mr Zhang recently pitched his research at the annual UNSW 3 Minute Thesis (3MT) academic competition, which showcases UNSW’s innovative PhD candidates, who have just three minutes to explain their world-changing research and why it is important. Mr Zhang's research examines whether the overall costs outweigh the benefits associated with mandatory quarterly reporting from UK investors’ perspective. Specifically, he investigates UK investors' stock market reaction to the public events leading to a change of enforcement of mandatory quarterly IMS in the UK. Those reactions represent the impact of the regulatory event on the stock market at the time, indicating whether investors perceive mandatory IMS as net beneficial or costly.
The cost-benefit trade-off of mandatory quarterly reporting
According to Mr Zhang, regulators worldwide are contemplating the necessity of mandatory quarterly reporting, with the SEC in the US requesting comments on its pros and cons. In the US, it is compulsory to issue quarterly financial reports. So knowing how mandatory enforcement affects investors' confidence and share market prices is essential to the debate.
In his study, Mr Zhang investigates whether investors perceived the overall costs of mandatory quarterly reporting outweigh the overall benefits and how this impacted share markets at the time. While past research has shown there are both pros and cons, few studies, if any, provide a cost-benefit analysis by examining investor reactions to the proposed mandate and then the effects of its dissolution.
Some pros of mandatory reporting include increased transparency, which is generally thought to enable investors to make more informed decisions. But increased reporting can also lead to more administrative costs and unintended consequences, including managerial short-termism and real activity manipulations, which can be evident from an abnormal reduction in R&D expenses and production costs.
Mr Zhang’s findings show UK investors react negatively to the events that increase the likelihood of mandating quarterly reporting. His results also show investors react positively when quarterly reporting is voluntary and negatively when it is mandatory. He explains that investors perceive mandatory quarterly IMS as net costly instead of net beneficial.
Specifically, the study finds that mean and aggregated abnormal returns of the UK stock market in reaction to mandate events are -0.96 per cent and -16.35 per cent, indicating an average 0.96 per cent and an aggregate 16.35 per cent reduction in firm value in response to the events leading to mandating quarterly IMS. In comparison, when news hit that quarterly IMS reporting was going to be scrapped, there was a positive abnormal return of 3.90 per cent. These findings are consistent with the notion that UK investors perceive the mandate of quarterly IMS as a net cost burden for firms.
“From the cross-sectional tests, I find investors with greater information demand react less negatively, and investors of firms facing a greater cost burden react more negatively. This result shows that the information demand and the cost concern are driving the differences in the investor reaction, despite that the overall reaction is negative,” he says.
“It was always argued that mandatory quarterly reporting is enforced to make the firms more transparent and protect investors, so it was surprising that investors perceive mandatory quarterly IMS to be net costly. This indicates that the benefits if any, may not be worth the cost,” he says.
Should mandatory quarterly reporting be scrapped?
So based on the evidence from the UK, quarterly reporting in the UK should stay voluntary. What about other countries? “The UK is a country with a good information environment. Therefore, quarterly reporting in the UK may not provide many benefits. On the other hand, suppose quarterly reporting is mandated in a country with a poor information environment. In that case, we might have a different story where investors might think the information benefits provided by mandatory quarterly reporting are well worth the costs,” he says.
What do these findings mean for Australian businesses? The implications might be similar in Australia because Australia has a Continuous Disclosure regime as required by section 674 of the Corporations Act 2001. “Firms are required to disclose price-sensitive information continuously. So mandatory quarterly reporting would provide little incremental information benefits in Australia. This is because any information that could affect share price would have already been disclosed following the continuous disclosure regime.”
Yuchen Zhang is a doctoral candidate and PhD Teaching Fellow in the School of Accounting, Auditing & Taxation at UNSW Business School. His research interests include financial reporting and disclosure and international accounting, and his PhD project focuses on the consequences of mandatory quarterly reporting. For more information, please contact Mr Zhang directly. Or click here to watch last year's UNSW 3MT winners present their research findings.