Mis-Guided

Here’s an issue that top managements in the banking business don’t spend enough time thinking about, but should: whetheru00e2u20ac”and to what extentu00e2u20ac”their companies should provide earnings guidance to Wall Street. My suggestion, for what it’s worth, is “Don’t give ’em nuthin’.” You laugh. But if your CEO follows my advice, he’ll save himself a lot of frustration and have time for more productive activities. And your company’s stock price will be none the worse for wear.

Alas, my view seems to be in the distinct minority. Last fall I hosted a dinner for 15 banking CEOsu00e2u20ac”some of the brightest in the businessu00e2u20ac”and asked whether, in this new era of Reg FD and greater management scrutiny, they planned on paring back their earnings guidance practices. To my surprise, few were. Rather, the consensus was to give as much disclosure as possible. More than a few CEOs favored, in the name of “transparency,” giving high-level P&L budgets that analysts could use in building their models. Others felt that they had a responsibility to provide input in the forming of consensus expectations for their companies.

To which I say, hooey! At too many companies, CEOs forget that their primary responsibility is to their shareholdersu00e2u20ac”not Wall Street analysts. They’ve somehow convinced themselves that if they can assure the Street of their companies’ future earnings and growth rates, by way of semi-official annual earnings “guidance” or “targets” or “budgets,” their companies’ stocks will be less volatile, and their P/E multiples might even rise.

The only problem with this approach is that it doesn’t worku00e2u20ac”and is probably counterproductive. First, I know of no evidenceu00e2u20ac”noneu00e2u20ac”that shows that stocks of companies that give detailed guidance have higher valuations than stocks of companies that don’t. Or are less volatile.

In the meantime, your openness comes with real costs. First, by providing line-by-line “transparency” to your shareholders, you’re giving transparency to your competitors, too. What, exactly, is the advantage in that?
Then there’s litigation risk. Most CEOs can provide a reasonably accurate forecast of the near-term trends in their business, of course. But none are clairvoyant. It’s simply too much to expect that a CEO can accurately project a company’s long-term growth rate with any accuracy, or predict to the penny how much his company will earn in the current and coming year.

Yet that’s what too many investors on Wall Street have come to expect. And if your company doesn’t deliveru00e2u20ac”pow! It will be hit with a lawsuit faster than you can say “contingency fee.” Sure, most suits won’t go anywhere, assuming you take advantage of the safe-harbor provisions of the 1995 litigation reform legislation. But litigation can still be a considerable distraction to management, not to mention bad publicity. The less guidance your company provides, the less likely you’ll be besieged by trial lawyers.

But there’s one benefit of kicking the guidance habit that towers over all the others. A no-guidance policy will free up your CEO’s most precious resource: his time. That can be huge. The fact of the matter (too often forgotten in many executive suites) is that the single most powerful driver of shareholder value is a company’s ability to grow its book value over time. And the best way a CEO can do that is to spend his time running the business for the long term, rather than “marketing” his stock via elaborate guidance schemes or making other short-term moves to please Wall Street at the expense of the long-term welfare of his shareholders.

Does all this mean that your company should shut down its IR department and clam up with investors? No way! A public company should be as forthcoming with its current and prospective shareholders as it can, consistent with securities laws and competitive constraints. But that does not mean it should do Wall Street analysts’ work for them, which, when you get down to it, is all the earnings guidance game really amounts to.

Rather, the best strategy is to get out of the guidance-dispensing business once and for all, and spend time instead building the business for the future. That way, you’ll get the long-term shareholders you deserve.