Investors have obviously become interested in accounting lately, often reacting with a vengeance to hints of trickery, or even hints of opacity, at companies they used to embrace. One novel example of “concern” resurfaces in an article in today’s Wall Street Journal, basically noting that the old investigation involving Microsoft is still ongoing. That’s not exactly hot news (and on an up day, the markets don’t seem to care, bidding up Mister Softee anyway), but the underlying allegation is worth a look because it sounds, at first, so peculiar.
What Microsoft (which owns Slate) is accused of doing is not pumping up its earnings, but rather falsely deflating them—”hoarding cash” in certain quarters to keep its profits looking less robust than they actually are. At various points in the past, GE has been accused of this, also (although the Securities and Exchange Commission, so far as I know, has never gotten involved).
Why would a company do such a thing? Modesty, perhaps? Not at all. Let’s set aside the question of whether Microsoft, GE, or any other firms actually have put a fig leaf over obscenely impressive numbers; the firms of course deny doing any such thing. The reason a company might be aggressively modest is actually closely related to the reason that other companies resort to desperate ploys to make their short-term financials look prettier. The reason is the quarter.
The rise of quarterly obsession has been lamented elsewhere. What sounds like a pretty good idea for the investors—frequent disclosure of a company’s performance—clearly has a down side: Too many businesses are managed for the very short term, because the markets pay a great deal of attention to the short term. If a company misses its quarterly numbers, or even if it meets “expectations,” but the numbers aren’t as good as last quarter or show a slowing trend, etc., the markets react. If they show an unexpected jump, the markets also react, positively. But what the markets like best of all is slow and steady predictability—”orderly earnings growth” is how this is often described.
In the boom years, the knock on the quarter-by-quarter process was that it was surrounded by so much hoopla that companies were cutting corners that might cost them in the long run. Lately we find ourselves in the long run, and the consequences of some of those maneuvers are coming into play. And one reason that a firm might stockpile earnings off the books in good times, of course, is to sneak them back in later—both to prevent an embarrassing down quarter and also to keep earnings results “orderly.” Another reason is that an especially gangbusters quarter might be difficult to top three months later, so it’s better, if possible, to tamp down those gangbuster results. This sounds absurd—how could investors punish a company for having an unusually good three months? But a side-effect of quarterly thinking is a quarterly memory: If it looks like a company’s earnings growth is slowing, the market often has little patience for the subtle reasons why.
And naturally the most troubling thing about hiding good news is that a company that does so might well be that much more willing to do the opposite, and find ways to hide bad news when things slow down. Ultimately, as Enron and others have reminded us lately, making the quarter hardly guarantees long-term success. But meanwhile, the quarter is what we’ve got, and it isn’t likely to go away. Maybe it’s true that any given quarter doesn’t mean much in the long run—but who can afford to wait for the long run?