Investors should ignore the rustles in the undergrowth


In the past few months, I have discovered that almost no one supports the obligation on listed companies to produce quarterly accounts or interim management statements. The European Union is now engaged in the slow process of removing this requirement.

This issue is the tip of a large iceberg. The common reaction to every failure in financial markets has been to demand more disclosure and greater transparency. And, viewed in the abstract, who could dispute the merits of disclosure and transparency? You can never have too much information.

But you can. There are costs to providing information, which is why these obligations have proved unpopular with companies. There are also costs entailed in processing information – even if the only processing you undertake is to recognise that you want to discard it. Many people resent junk mail as they throw it away and pay to have spam filters installed on their computers. They are not convinced by the argument that you never know when you might need counterfeit Viagra or a replica Rolex.

But these direct costs of unwanted data are often small relative to the indirect costs. Even if information is useless or misleading, it influences behaviour. This effect may be hard-wired: our ancestors looked for clues that might help them to spot wild game or hostile tribes, and had to accept that most of the rustles in the undergrowth were the wind rather than the meat.

It was not long before charlatans exploited the need for reassurance in an uncertain world to tell their customers they could make better decisions by examining the entrails of sacrificial animals and observing the movements of the planets. Not everyone has the confidence to tell respected authorities, whether they are priests or chartered accountants, that they are talking nonsense.

Even if the tendency to absorb what we do not need to know is not in our genes, it is certainly part of our conditioning. If we had not been required to pay attention to information we thought at the time was useless, few of us would have learnt much at school.

One experiment in behavioural economics nicely illustrates the problem. The subjects were asked questions to which they did not know the answer, such as: “How many African countries are members of the UN?” At the front of the room, a man rotated a wheel with numbers on it. The figure displayed by the wheel had considerable influence on the estimates: the higher the number, the more independent African countries the respondents believed there were.

In conditions of ignorance, people seize on any information available, even if their reason should tell them that it is irrelevant. Just watch the occupants of the airport lounge fiddling with their BlackBerrys. Few people with an investment portfolio can resist the temptation to check its value whenever they get a chance – even though they know, or ought to know, that most short-term share price movements are only the noise of rustling undergrowth.

Annual reporting dates from a time when agriculture was the principal form of economic activity and there are still some businesses – such as retailers – for which the year is probably a relevant timescale. But for many others business – oil companies or builders – the relevant timescale for measuring the consequences of actions is much longer. When I asked a group to think of an entity for which the relevant cycle was three months, the only suggestion offered was banks.

That judgement could hardly be more wrong. The underlying profitability of most financial activities can be judged only over a complete business cycle – or longer. The damage done by presenting spurious profit figures, derived by marking assets to delusionary market values or computed from hypothetical model-based valuations, has been literally incalculable.

The tyranny of quarterly earnings has created a dysfunctional cycle of smoothed and exaggerated numbers and relations between companies and analysts based on earnings guidance, an activity almost unconnected to the real business of the company and to assessing its progress. “Never mind the quality, feel the length” has been the guiding principle of corporate disclosure for too long. It is time companies and their investors got together to identify information, usually sector specific, relevant to their joint needs.

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