An
article titled "FERF [Financial Executives Research Foundation]
@65-Financial Reporting's Eternal Quest:
What Do Users Want/Need?" by William Sinnett and Roland Laing,
which appeared in the December 2009 issue of Financial Executive, discussed the
decades-long debate about the constant pressure from shareholders of U.S.
companies to report more and more financial information, including publishing
earnings forecasts. As far back as 1972, the Securities Exchange Commission
said it was reconsidering its longstanding opposition to the publication of
forward-looking statements. By 2003, some 84 percent of partners in the
international accounting and consulting firm Deloitte said that they had
clients who published financial forecasts. In the following years, two reports
co-authored by Robert J. Kueppers, a senior Deloitte executive determined that
there was no conclusion as to whether companies should release any
forward-looking information. The second report, released in 2009, recommended
that corporations weigh the risks and benefits of releasing specific financial
forecasts. "And, as an alternative to forward-looking earnings targets, a
company may favor providing robust historical information on a more real-time
basis and allow investors and analysts to make their own predictions,"
Sinnett and Laing said of the 2009 report.
Instructions
(a)
What are the risks and benefits of providing forward-looking information?
(b)
What is the purpose of the safe harbor rule?
(c)
Why might providing more "robust historical information on a more
real-time basis" assist analysts and other users to make their own
forecast?
(a) Benefits
for providing forward looking information would include the following:
1. Investment decisions are based on future
expectations; therefore, information about the future would facilitate better
decisions.
2. Forecasts are already circulated informally,
but they are uncontrolled, frequently misleading, and not available equally to
all investors. This confused situation should be brought under control. 3. Circumstances
now change so rapidly that historical information is no longer adequate as a
base for prediction.
Risks related
to preparing a forecast are as follows:
1. No one can foretell the future. Therefore
forecasts, while conveying an impression of precision about the future, will
inevitably be wrong.
2. Organizations
will strive only to meet their published forecasts, not to produce results that
are in the shareholders’ best interest.
3. When forecasts are proven not to be accurate,
there will be recriminations and probably legal actions. Even with a safe
harbor rule, enterprises are concerned because the definition of reasonable is
subjective.
4. Disclosure of forecasts will be detrimental to
enterprises because it will fully inform not only investors, but also
competitors (foreign and domestic).
(b) The
purpose of a safe harbor rule is to provide protection to an enterprise that
presents an erroneous projection, as long as the projections were prepared on a
reasonable basis and were disclosed in good faith. An enterprise’s concern with
the safe harbor rule is that a jury’s definition of reasonable might be at
variance with the company’s.
(c) More robust information would be a better
explanation of historical results which might include the following as
examples:
·
Volume and price changes
related to revenues;
·
Revenues caused by organic
growth versus acquisitions;
·
Raw material input price
changes;
·
Impact of foreign currency
rate changes on revenues and costs;
·
Classification of costs into
fixed versus variable; and
·
Impact of competition on
revenues and costs.
With more detailed information on historical results,
analysts and users have better information to build more accurate forecasts on
their own. This would reduce the risks
for enterprises having to provide this information.
