Information Timing and Release: The Gaming of Guidance!

    I am a lapsed academic, insofar as I have not submitted a paper for publication in more than two decades, but to acquire academic status, I did have to earn a PhD in the distant past. My doctoral dissertation, which like most doctoral theses is little noted and long forgotten, was completed in 1984 and focused on how the frequency of and delays in the release of information plays out in stock price volatility, skew and jumps. I don't plan to rehash that paper, but there have been two long running news stories that reminded me of it. The first is a proposal being floated by the Securities Exchange Commission (SEC) to replace quarterly reporting of financial statements by companies with semi-annual reporting. The second is the opinion voiced by Kevin Warsh, the new Fed Chair, that the Fed should provide less guidance to financial markets on future decisions.

    The two stories may seem unconnected, but they have two common features. First, both actions (removing quarterly reporting requirements and reducing/eliminating Fed guidance), if carried through, will remove "news" that markets have become used to receiving and using to calibrate prices.  Second, the arguments for and against each of these proposals have parallels. The advocates for removing quarterly reports argue that they feed into market myopia and increase short-termism in markets, and the supporters of less Fed guidance believe that this guidance creates gaming among traders and investors, increasing focus on the FOMC actions at the expense of fundamentals. The pushback against both proposals comes from those who believe that withholding quarterly reports and Fed guidance removes information that markets use to set prices, making these prices more volatile and less informative. As is almost always the case with these debates, there is both truth and hyperbole on both sides, and I will try to thread the needle.

Earnings Reports

    Most investors and traders in equity markets, and especially so in the United States, have spent their investing lifetimes in an environment where companies not only release full financial statements every quarter, but do so with fan fare. As we will note in this section, that has not always been the case, even in the US, and has more recent origins, with setbacks, in many foreign markets. 

The History of Earnings Reporting Periodicity

   The Securities Exchange Act of 1934, which created the SEC, set up foundational annual reporting requirements (10-Ks) for publicly traded companies, modified in 1955 to require semi-annual reporting and in 1970, quarterly reports, within 45 days from the end of each quarter. That said, there have been forces that have induced firms to report earnings on a more frequent basis to investors well before these regulatory requirements were put in place. The first were the stock exchanges that imposed their own constraints, with the NYSE requiring most firms to report on a quarterly basis as early as 1939. The second was the recognition by firms that financial transparency (in the form of more frequent and more detailed financial reports) could make them more attractive to investors. As a consequence, it is estimated that in 1931, prior to either the SEC or NYSE mandating disclosure, more than 60% of publicly traded companies were already disclosing information on a quarterly basis.

    The shift to more frequent reporting was slower in the rest of the world and has seen more reversals. Europe, for much of the last century, has a patchwork of rules, with some countries adopting stricter disclosure laws than others. The UK imposed mandatory quarterly earnings reporting in 2007, but allowed a shift back to semi-annual reporting in 2014, and the EU also followed a similar timeline, introducing quarterly reports in 2007 and withdrawing that requirement in 2013. In 2003, Singapore started requiring quarterly reporting for firms with market capitalization exceeding S$20 million, but in 2020, shifted away to requiring it only for a subset of firms with financial and regulatory concerns. Japan started its quarterly reporting requirements in 2003 as well, but it too reversed that requirement in 2024.  In emerging markets, there are large variations across countries. In India, publicly traded companies are required to report their financials on a quarterly basis, and the same is true for many Brazilian and Chinese companies. In Africa, Nigeria requires quarterly reporting but South Africa  has a semi-annual reporting mandate, though many companies voluntarily release quarterly financials; much of the rest of Africa has semi-annual reporting requirements. 

    In sum, the belief at the start of the twenty first century that the rest of the world would follow the US model of mandated quarterly reporting for publicly traded companies has not come to fruition, as many parts of the world have experimented with mandatory quarterly reporting, before abandoning it in favor of semi-annual reporting, for a variety of reasons. That said, it is worth noting that a significant percentage of firms voluntarily report their financial results on a quarterly basis, even when not mandated, albeit with different degrees of depth.

The Content of Earnings Reports

    The debate about how frequently companies should report their financials misses a key detail related to what their financial reports include as content. Focusing on the US, for instance, the magnitude of quarterly earnings reports has increased over time, expanding from bare bones financial statements fin the 1970s to much larger documents that go well beyond financial statements today. In 1980, for instance, a typical quarterly earnings report contained 2000-5000 words, but by the turn of this century, those reports had tripled or quadrupled in size, and the trends continue. The graph below, for instance, looks at the growth in word count for the median quarterly and annual reports in the Russell 3000 companies between 2006 and 2020 (for quarterly) and 1994 to 2020 (for annual):

As you can see the number of words in both quarterly and annual reports has increased over time, and the bulking up of earnings reports can be explained by multiple factors:

1. Accounting rule changes: Accounting rule writers have been busy adding more items to the list of required disclosures for public companies in the last few decades. Some of this increased disclosure (stock-based compensation, for example) reflects a changing business world and is merited, some is in reaction to a corporate scandal and if often knee-jerk and some, in my cynical vie, reflects accounting trying to be relevant to markets again. 
2. Macro events: In years of market crises, economic or political, you will see disclosures increase. In the graphs above, notice the spikes in 2008/2009 and 2020, the first in response to the 2008 banking crisis and the latter to COVID.  Superimposing the effects of globalization, where a company finds itself exposed to problems in every corner of the world, it has added to the disclosure bloat.
3. Legal Protection: One of the culprits responsible for disclosures bulk is the risk exposure section, where companies are required lay out an exhaustive (and exhausting) list of things that can go wrong in their business models. I have never found a risk disclosure useful in a valuation, as it seems to be written by lawyers with the objective of providing legal cover.
4. Guidance: In the 1980s, quarterly earnings reports were focused on reporting on operations during the quarter in question and management was not expected to, and did not provide, guidance about future quarters. That started to change in the 1990s, especially with the passage of the 1995 Safe Harbor Law and Reg FD (which prevented companies from selectively leaking information to analysts), and surged through the second half of the decade, peaking in 2003, when more than 50% of all companies providing earnings guidance. Thankfully, the process has receded, with only a fifth of all firms now providing guidance with earnings reports, but it is undeniable that there is much more forward-looking components to earnings reports than used to be the case.

The bulking up of earnings reports is part of a phenomena that I term "disclosure diarrhea" and argue has undercut the usefulness of these reports, with more disclosure perversely making for less information.

The Earnings Game

    To make sense of the arguments for and against quarterly earnings reporting, you have to get a measure of what happens leading into and out of these reports, in the "earnings game". The process starts with analysts and investors making forecasts of what the earnings report will contain, almost always including estimates of the earnings per share, but often also containing estimates of expected revenues and even operating metrics (like margins) for high profile companies. The analyst forecasts, at least from sell side analysts, become quasi public information and are often aggregated and reported as consensus estimates by financial news services. Zacks, for instance, is one of the services that has been doing this for decades, but that information is now widely accessible on Google and Yahoo! Finance (with the estimates for Apple on July 27, 2026, for the September 2026 earnings report, shown below):

Yahoo! Finance for Apple earnings forecasts

These analyst forecasts, once made, are revisited, partly in response to company-specific news stories and partly to macroeconomic developments, and revised forecasts are provided, with services again tracking these revisions for trends (as you can see below for Apple, from Zack's):

Zack's Apple earnings revisions

As the earnings release date approaches, analysts continue to revise their estimates, and on the date of the announcement, the actual earnings per share is compared to the expected number, with higher (lower) than expected earnings labeled as positive (negative) surprises. The market price response is often consistent, with positive (negative) earnings surprises translating into increases (decreases) in stock price. The graph below, while dated, looks at stock price responses to earnings surprised classified into ten deciles (from most positive to most negative):

There is some evidence that the market responses to earnings reports have become more muted over time, perhaps because of public access to analyst forecasts and revisions. The link between earnings surprises and stock price changes has become the reason why analysts spend as much time as they do, forecasting earnings per share in the next quarterly report, and why traders focusing on the same metric. There is another aspect of the market reaction to earnings surprises that becomes grist for the trading mill, and it comes from the price drifts in the days after earnings are released, with positive (negative) surprises followed by upward (downward) drifts. While the price drift is small, it may still be large enough to make a difference in active trading, where winning by inches is still winning.

    As with almost everything else that is market-related, there are no easy wins in this game, and as more and more people play the earnings forecasting game, new wrinkles have emerged. First, companies have learned to use the flexibility embedded in accounting rules to find ways to beat analyst estimates, with tech companies, in particular, standing out. That earnings gaming plays out as a disproportionately large number of positive earnings surprises (at least among the S&P 500 companies, broken down by sector), as is clear from earnings surprises at the  S&P 500 companies in the second quarter of 2026:

Source: Factset

Second, as companies routinely beat analyst estimates, markets readjust, creating the phenomenon of whispered earnings, where investors build in the expectation that a company that has historically delivered earnings that are 5% or 10% above estimates will continue to do so, and a lesser number is a negative surprise. In the graph below, I look at the market price reaction to earnings surprises in the second quarter of 2026:

Source: Factset

As you can see, the linkage between earnings surprises and price reaction is weak, with a significant subset of positive surprises resulting in price drops. 

The Bottom Line

    Much of the debate about whether the US should shift away from quarterly to semi-annual reports can be boiled down to what you think about the time and energy investors and companies spend playing the earnings game, and where that time and energy will be spent in the absence of quarterly reports. Those who are advocates for less frequent reporting are of the view that the earnings game, focused as it is on next quarter's earnings estimates and whether the company can beat them, contributes to short-termism and distracts from fundamentals. Those who are pushing for preserving the status quo (of quarterly reporting) believe that removing quarterly reports will just shift the game, perhaps more intensively, into the semi-annual reports and that there is value to long term investors from having quarterly reports, gaming notwithstanding. 

    There is another issue that comes up in the context of quarterly reporting, and what would happen if these reports did not exist. Legal strictures notwithstanding, insiders (from within and outside the firm) trade and make money on material information that they have access to, but the public does not. Removing quarterly reporting will create more of an opening for insiders to make money at the expense of public market investors, and while inside trading may contribute to making prices more informative, it also adds to the sense that financial markets are an unfair game.

    I am an investor, and I  think that there is a compromise solution that draws on both sides of this argument. I like quarterly reporting for two reasons. 

1. There is information in those reports that allows me to update my company valuations, though for many companies, the marginal impact of a quarterly report on value is small. 
2. While I have no interest in playing the earnings game, the price corrections that happen around earnings reports serve two purposes. For companies that I have a position in, they can operate as catalysts, bringing down (up) the stock price of over valued (under valued) companies. At the same time, almost all of the information that I find useful in an earnings reports is in the financial statements and footnotes, not in the lengthy discussions of risk exposure or in the management guidance, and I would welcome an elimination of these sections and a slimming down of these reports. 

Note that none of my arguments for preserving quarterly reporting are about short-termism, and that is intentional. First, I am not sure what short-termism even means, since the cynical answer seems to be that any market movement away from your preferred price direction is short term, and any movement in your favor is indicative of market wisdom. Second, I believe that most market participants, and this is true across time and markets, trade to make money in the near term, and that there is nothing that regulators or rule writers can do to alter this dynamic. In fact, the magic of markets is that millions of trades motivated by opportunism and the short term can still yield a price that is long term and rational. Finally, it remains true that if we were all long-term investors who traded only when the fundamentals drove us to do so, markets would be less liquid and transactions costs would increase; short term traders provide a market service and supply liquidity that we all (including long term investors) benefit from.

    I hope that the SEC preserves the current quarterly reporting requirement, while scaling back the volume of disclosure, but if it decides otherwise, it will not materially change much of what I do. I will miss the quarterly updates more with younger, higher-growth firms, where the operating metrics (revenues, margins etc.) can change quickly over short periods, but it is my guess that many of these firms will voluntarily continue the quarterly reporting tradition. 

Fed Guidance on Rates

    For most investors who started investing after 2008, the Fed, in particular, and central banks, in general, have loomed large in the investing process. Many investors attribute the low interest rates after 2008 almost entirely to Fed actions, and by extension, blame the Fed for the higher rates since 2022. I have long argued that not only is this perception incorrect, but that it is unhealthy for investors to view the Fed as either savior or villain. 

A Short (and Personal) History of the Fed

    I started in equity markets in the 1980s, when Paul Volcker as the chair of the Fed played a central role in getting inflation back into check. I might have been ignorant, but I did not know the names of any of the members of the Federal Open Market Committee and had no idea when they met. Changes in the fed funds rate, the only rate effectively controlled by the FOMC, would percolate their way into markets, but I don't remember them being central to equity market movements. 

    Volcker was followed by Alan Greenspan, and while he acquired rockstar status (at least  among investors) in the late 1990s, his views on rates were superseded by his views on equity investors (and their irrational exuberance). The FOMC met eight times per year during that period, and you can access the meeting minutes and actions on the Fed website here, but it stayed away from explicit guidance about future rate changes, choosing to send subtle hints instead. 

    The sea change in Fed behavior and centrality occurred with the 2008 market crisis, when the Fed first introduced explicit guidance noting that rates would stay low "for some time", and it has largely continued that practice through the stewardships of Bernanke (2006-2014), Yellen (2014-2020) and Powell (2020-2026). Along the way, its place in markets has changed, as both bond and equity investors have become focused on the Fed as the arbiter of interest rates and director of the economy. 

The Fed's Powers (and Powerlessness)

    To understand the extent and limits of the Fed's capacity to guide rates and the economy, it is useful to begin with an understanding of what it does. Through its twelve districts that span the United States, the Fed collects information on almost every aspect of the economy, from price pressures building on consumers and producers to the pace of economic growth. While there are other government agencies that also track these statistics, it is undeniable that the Fed has a big picture view and access to more data than any other government agency. The Federal Open Market Committee, composed of all of the members of the board of governors and representatives of the district presidents, sets Fed policy on open market operations (where the Fed buys and sells US government securities), the size of the Fed's balance sheet and the Fed Funds rate (an overnight rate at which banks can borrow and lend their reserves). In addition to the FOMC providing policy direction on inflation and the economy, the Fed chair testifies to Congress every six months, facing and answering questions from legislators.

    As the key interest rate set by the Fed, the Fed Funds rate often acquires an outsized role and there are good reasons to pay attention to it. First, it operates as a signal of what the Fed is seeing in the data it has collected on the economy, with an increase (decrease) in rates indicating that it sees higher (lower) inflation and an overheated (slowing) economy. Second, there are interest rates that are directly tied to the Fed Funds rate, where changes percolate down to businesses and customers; the prime rate and some credit card and CD rates move with the Fed Funds rate. That said, I believe that Fed's capacity to affect interest rates is far more limited than most believe, for two reasons. First, while there is positive correlation between Fed Funds rates and short-term market-set rates (like the US treasury bill rate), there is as much evidence (if not more) that the latter lead the former, rather than the other way around. Put simply, Fed funds rates tend to be increased (cut) after short term treasury rates have gone up (down), suggesting that the Fed is mimicking the market. Second, the relationship between Fed Funds rates and long-term market-set rates, which drive asset valuation and affect borrowers more, is even weaker. To back these contentions, I chart the effective fund funds rate, the three-month US treasury bill rate and the 10-year treasury note rate on a monthly basis from January 1962 to June 2026:

Download data

At the bottom of the graph, I have a table where I look at the data on a quarterly basis, and break it down into three groups - quarters where the fed funds rate decreased, quarters where it increased and quarters where it stayed unchanged. With both fed funds rate increases and decreases, you can see that the link with short term rates is stronger, and with both short term and long term rates, the bulk of the change in rates happens prior to or in the quarter that the Fed Funds rate changed, but there is only a mild spill over into the quarter after, with three month rates, and almost no spillover, with long term rates. Put simply, baed on this history, it looks like changes in fed funds rate are less signals of future movements in interest rates and more reflectors of changes that have already happened.

    The Fed's weaknesses in setting interest rates also plays out in its capacity to alter the trajectory of the real economy. While there are clearly periods that you can point to where Fed actions have had a material impact on he economy, with the Fed Fund rate was hiked to 20% under Paul Volcker in 1981, and triggering a deep recession, being a prime example, the link between Fed Fund rates and economic growth remains tenuous. In the graph below, I look at the changes in Fed Funds rates and real GDP growth in the quarter leading into, the quarter of and the quarter after the change:

Download data (FRED)

Again, there is little backing for conventional wisdom, which is that fed tightening (by raising the Fed funds rate) leads to drops in real growth (or even recessions) and that fed loosening (by lowering the Fed funds rate) is a signal of higher economic growth in the future. In fact, the more general conclusion that one can draw from the data is that the fed effect on the real economy has been more "meh" than "wow".

    The gap between investor perception on what the Fed can control on interest rates and the economy and its actual powers is not just wide, but potentially dangerous. From a policy perspective, it can lead to perverse actions, where central banks are pressured to lower the rates they control (like the Fed Funds rate) in the face of high inflation, leading to even higher inflation in the future. From an investor and business perspective, the focus on what the Fed is doing or will do can take attention away from the fundamentals, especially inflation, that ultimately drive both interest rates and growth.

Download data

As you can see, much of the variation in long term interest rates (with the ten-year US treasury rate standing in as proxy) can be explained by movements in inflation and real economic growth over time, not Fed action or inaction.

The Warsh Doctrine?

    All Fed chairs have had to wrestle with the problem of being perceived as all-powerful, when their true powers are limited, but Kevin Warsh is perhaps more exposed than any of his predecessors. The market fixation with the Fed is now deeply embedded in market, and there are politicians on both sides of the aisle who seem to think that Warsh can bring rates (mortgage, treasury) down to 2% or lower, if he so desires, when the truth is that with inflation expectations running at 2.5-3%, there is no chance of that happening. 

    The pathway out of this problem will be long and there will be pushback, but the end game should be a world where you see and hear from the Fed less, not more. I do believe that the decision to reduce or withhold guidance is a good first step, and it has to be followed by more open humility from the Fed (and from Warsh) about the limits of its powers and honesty about how frequently it follows markets, rather than leads them. In the context of today's (July 29, 2026) decision by the FOMC to leave rates unchanged, for instance, the subtext is that while inflation is running hotter than desired (3% or more, as opposed to the targeted number of 2%), much of that inflation is being driven by a war and its effect on oil prices

    There will be some who feel that markets will be lost without Fed guidance, but I don't think so. After all, financial markets set interest rates and stock prices before the guidance era, and did a pretty good job. In fact, I think that the surge in guidance from the Fed has led many in markets to abdicate their responsibility for paying heed to fundamentals and gauging what interest rates should be. 

Conclusion

    If there is a takeaway from this post, it should be that there is nothing inherently good about having more disclosure. In fact, there is a tipping point, where information overload can cause investors to behave in perverse ways. Thus, I am less of an absolutist about the quarterly versus semi-annual reporting debate than some, though my view is that rather than reduce the frequency of reporting, the SEC should be looking at slimming down reports, by replacing one-size-fits-all disclosure requirements with targeted disclosures and keeping the focus on reporting what has happened rather than prognosticate about the future. 

    With the Federal Reserve too, I think less is more is a better strategy - less guidance from the Fed about what it will do in the future, less opining from FOMC members about interest rates and the economy and less attention to FOMC meetings and the smoke signals that emerge from these meetings. Markets will step in to fill the vacuum, and that is good not just for investors but for the Fed, since its decisions are informed by those market judgments.

YouTube Video

Data

1. Fed Funds Rates and US Treasury rates, by month (1962-2026)
2. Fed Funds Rates and Real GDP growth, by quarter (1962-2026)
3. Intrinsic risk free rates and 10-year Treasuries (1954-2025)

Triggered Disclosures: Escaping the Disclosure Dilemma

In a post a few weeks ago, I argued that the disclosure process had lost its moorings, as corporate disclosures (annual filings, prospectuses for IPOs) have become more bulky, while also become less informative. I argued that some of this disclosure complexity could be attributed to the law of unintended consequences, with good intentions driving bad disclosure rules, and that some of it is deliberate, as companies use disclosures to confuse and confound, rather than to inform. For those of you who agreed with my thesis, the end game looks depressing, as new interest groups push for even more disclosures on their preferred fronts, with the strongest pressure coming from the environmental, social and governance (ESG) contingent. In this post, I propose one way out of the disclosure dilemma, albeit one with little chance of being adopted by the SEC or any other regulatory group, where you can have your cake (more disclosure on relevant items) and eat it too (without drowning in disclosure). 

The Disclosure Dilemma: Disease and Diagnosis

    For those of you who did not read my first post on disclosures, let me summarize its key points. The first is that company disclosures have become more bulky over time, whether it be in the form on required filings (like annual reports or 10K/10Q filings in the US) or prospectuses for initial public offerings.  The second is that these disclosures have become less readable and more difficult to navigate, partly because they are so bulky, and partly because disclosures with big consequences are mingled with disclosure with small or even no consequences, often leaving it up to investors to determine which ones matter. The net effect is that investors feel more confused now, when investing in companies, than ever before, even though the push towards more disclosures has ostensibly been for their benefit.

    As we look at the explosion of disclosures around the world, there are many obvious culprits. The first is that technology has made it possible to collect more granular data, and on more dimensions of business, than ever before in history, and to report that data. The second is that interest groups have become much more savvy about lobbying regulatory groups and accounting rule writers to get their required data items on the required list. The third is that companies have learned that converting disclosures into data dumps has the perverse effect of making it less likely that they will held accountable, rather than more. That said, there are three other reasons for the disclosure bloat: 

• The first is the prevailing orthodoxy in disclosure is tilted towards "one size fits all", where all companies are covered by disclosure requirements, even if they are only tangentially exposed. Though that practice is defended as fair and even handed, it is adding to the bloat, since disclosures that are useful for assessing some firms will be required even for firms where they have little informative value. 
• The second is the notion of materiality, a key component of how accountants and regulators think about what needs to be disclosed.  Using the words of IFRS (1.7), ‘Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity’. As we will argue in the next section, this definition of materiality may be leading to too much disclosure for backward looking items and too little for forward looking items.
• The third is that the disclosure rule writers happen to be in the disclosure business, and since more disclosure is good for business, the conflict of interest will always tilt toward more rather than less disclosure. No matter how many complaints you hear from accountants and data services about disclosure bloat, it has been undeniable that it has created more work for accountants, appraisers and others in the disclosure ecosystem.

It is quite clear, though, that unless we break this cycle, where each corporate shortcoming or market upheaval is followed by a fresh round of new disclosures, we are destined to make this disclosure problem worse. In fact, there may come a point where only computers can read disclosures, because they are so voluminous and complicated, perhaps opening the door for artificial intelligence or matching learning into investing, but for all the wrong reasons.

Escaping the Disclosure Trap

    There is a way out of this disclosure trap, but it will require a rethink of the status quo in disclosures. It starts first by moving away from "one size fits all" disclosure rules to disclosures tailored to companies, a "triggered" disclosure process, where a company's value story (big market, lots of subscribers) triggers disclosures on the parameters of that story. It extends into materiality, by reframing that concept in terms of value, rather than profits, and connecting it to disclosure, with disclosure requirements increasing proportionately with the value effect. Finally, it requires creating a separation between those who write the disclosure rules and those who make money from the disclosure business.

One size (does not) fit all!

When disclosure laws were first written in the aftermath of the great depression, they were focused on the publicly traded firms of the time, a mix of utilities, manufacturing and retail firms. At the time, the view that disclosure requirements should be general, and apply to all companies, was rooted in the idea of fairness. In the decades since, there have been exceptions to this general rule, but they have been narrowly carved out for segments of firms. For instance, oil companies are required to disclose their ownership of "proven undeveloped reserves", in addition to details about quantity, new investments and progress made during the year in converting those reserves. The disclosure rules for banks and insurance companies require them to reveal the credit standing of their loan portfolios and their regulatory capital levels to investors and the public. These exceptions notwithstanding, disclosure laws written to cover concerns in one sector (such as the use of management options at technology firm or lease commitments at retail and restaurant companies) have been applied broadly to all companies. It is time to rethink this principle and allow for a more variegated disclosure policy, with some disclosures required only fir subsets of companies. Since the next big bout of disclosures that are coming down the pike will be related to ESG, this discussion will play out in a wide range of ESG data items. For instance, while it makes sense to require that fossil fuel and airline companies report on their carbon footprints and greenhouse gas emissions, it may just be a time consuming and wasteful exercise to require it of technology companies.

From earnings-based to value-based materiality

I do not think that you will find many who disagree with the premise that any information that has a material effect should be disclosed, but there is disagreement on what comprises materiality. I believe that the "materiality principle", as defined by accountants, is diluted by measuring it in terms of impact on net income and the fact that accountants tend to be naturally conservative in measuring that impact. Simply put, it is safer for an accounting or audit firm to assume that a disclosure is material, and include it in reports, even if it turns out to be immaterial, than it is to assume that it is immaterial, and be found wrong subsequently.  One solution to this problem is to redefine materiality in terms of effects on value, rather than earnings, thus accomplishing two objectives. First, it will reduce the number of noise disclosures, i.e., those that pass the materiality threshold for earnings, but don't have a significant impact on value. Second, since value is driven by expected cash flows in the future and not in the past, it will shift the focus on disclosures to items that will have an impact on future earnings and cash flows, rather than on past earnings or book value.

Triggered Disclosures

At first sight, the requirements to make disclosures slimmer and more informative may seem at war with each other, since disclosure bloat has largely come from well-intentioned attempts to make companies reveal more about themselves. Triggered disclosures, where disclosures are tailored to a company's make-up and stories, are one solution, where contentions made by a company trigger additional disclosures related to that contention. Thus, a company that claims that brand name is its supreme competitive advantage would then have to provide information to not only back up that claim, but also to allow others to value that brand name. 

Disclosure Illustration: Initial Public Offerings

    

It is difficult to grapple with disclosure questions in the abstract, and to illustrate how my proposed solutions will play out in practice, I will focus on initial public offerings, where there is a sense that the disclosure rules are not having their desired effect. In my last post, I noted that prospectuses, the primary disclosure documents for a companies going public, have bulked up, contrasting the Microsoft and Apple prospectuses that came in at less than a 100 pages in the 1980s to the 400+ page prospectuses that we have seen with Airbnb and Doordash in more recent years. At the same time, applying a disclosure template largely designed for mature public companies to young companies, often with big losses and unformed business models, has resulted in prospectuses that are focused in large parts on details that are of little consequence to value, while ignoring the details that matter.  Since companies going public often do so on the basis of stories that they tell about their futures, and these stories vary widely across companies, this segment lends itself well to the triggered disclosure approach. To do so, I will draw on a paper that I co-wrote with Dan McCarthy and Maxime Cohen, to provide details. In that paper, we argue that a going-public company that wants to build its story around certain dimensions (a large total addressable market or a large user base) will trigger disclosure of a more systematic, business type-specific, collection of “base disclosures” that are required to understand the economics of businesses of that type, whatever type that might be.

Total Addressable Market (TAM)

Companies going public have increasingly supported high valuations by pointing to market potential, using large TAMs as one of the justifications. These TAMs are often not only aspirational, but also come with very little justification and no timeline for how long it will take for the existing market sizes to grow into those TAMs. For instance, the graph below shows the TAMs that Uber and Airbnb claimed in their prospectuses at the time of their initial public offerings.

Uber and Airbnb Prospectuses

Is Uber’s total addressable market really $5.2 trillion? I don’t think so, but you can see why the company was tempted to go with that inflated number to push a “big market” narrative. To prevent the misuse of TAM as little more than a marketing ploy, companies that specify a TAM should also have to provide the following:

a. TAM, SAM and bridges: Companies that specify a TAM should also specify the existing market size (i.e., the serviceable addressable market or SAM), as well as additional “bridges” so that investors can understand the evolution from SAM to TAM (e.g., an estimate of how many individuals would be interested in the company’s product before considering price). Investors who may be skeptical of a lofty TAM could still look to SAM as a more achievable intermediate metric.

b. Market share estimates: As long as companies do not have to twin TAM with expectations of market share, there is little incentive for them to restrain themselves when estimating TAM. We would recommend requiring that companies that disclose TAM figures couple them with forecasts of their market share of those TAM figures. For companies that are tempted to significantly inflate their TAMs, the worry that they will be held accountable if their revenues do not measure up to their promises, will act as a check.

c. Ongoing metrics or measures: Companies usually provide TAM, SAM, and variants thereof on a one-shot basis, disclosing these figures in their pre-IPO prospectuses and then never again. We believe that investors should be given these measures on an ongoing basis. This will help on two levels. First, it will allow investors to see how well the company is adhering to its prior disclosures and forecasts and provide investors with updates if conditions have changed. Second, companies that know they will be held accountable to their IPO disclosures after they go public will be more incentivized to make those disclosures realistic and achievable. 

To the extent that investors will continue to assess premiums for companies that have bigger markets, the bias on the part of companies will still be to overestimate TAM. That said, these recommendations should help rein in some of those biases.

Subscription-Based Companies

A subscription-based company derives its value from a combination of its subscriber base (and additions to it) and the subscription fees its charges these subscribers.  Consequently, the value of an existing subscriber can be written as the present value of the expected marginal profit (subscription fee net of the costs of servicing that subscription) from the subscription each year, over the expected life of the subscriber (based upon renewal/churn rates in subscribers), and the value of a new subscriber will be driven all of the same factors, net of the cost of acquiring that subscriber. The overall value of the company can be written in terms of its existing and new subscribers:

Companies that sell a “subscriber” story have the obligation, then, to provide the information needed to derive this value:

1. Existing subscriber count: Observing the total number of subscribers in each period (e.g., month or quarter) allows us to track overall growth trends in the number of subscribers, and to understand how revenue per subscriber evolves over time, because revenue is disclosed.
2. Subscriber churn: To value a subscriber, a key input is the renewal rate or its converse, the churn rate. Holding all else constant, a subscription business with a higher renewal rate should have more valuable subscribers than one with a lower renewal rate. It would stand to reason that any subscription-based company should report this number, but it is striking just how many do not disclose these measures or disclose them opaquely. For example, while the telecom industry regularly discloses churn figures, Netflix has not disclosed its churn rate in recent years. 
3. Contribution profitability: For subscribers to be valuable, they need to generate incremental profits, and to estimate these profits, you need to know not just the subscription fees that they pay, but also the cost of servicing a subscription; the net figure (subscription fee minus cost of service) is called the contribution margin. Many subscription companies explicitly disclose contribution profits (e.g., Blue Apron, HelloFresh, and Rent the Runway), but many others do not (e.g., StitchFix). In the absence of explicit contribution profit data, investors often resort to simple proxies for it, such as gross profit, but these proxies are imperfect and noisy.
4. Subscriber acquisitions & drop offs: To move from the value of a single subscriber to the value of the entire subscriber base, we must also know how many subscribers are acquired over time, not just the net subscriber count. Put differently, if a company grew the overall size of its subscriber base from 10 million to 12 million subscribers in a year, it is quite different if that net growth came about because the company acquired 10 million customers that year but then lost 8 million of them, versus if the company acquired 2 million customers and lost none of them. Acquisition (or equivalently, churn) disclosures are what allow us to piece this apart.
5. Cost of acquiring subscribers (CAC): Subscription-based companies attract new subscribers by offering special deals or discounts, or through paid advertising. While the cost of acquiring subscribers can sometimes be backed out of other disclosures at subscription-based companies (such as subscribers numbers, churn and marketing costs), it would make sense to require that it be explicitly estimated and reported by the company.
6. Cohort data: While many subscriber companies are quick to report total numbers, only a provide a breakdown of subscribers, based upon subscription age. This breakdown, called a cohort table, can be informative to observe retention and/or monetization patterns across cohorts, as noted by Fader and McCarthy in their 2020 paper on the topic. Many subscription-based firms, including Slack, Dropbox, and Atlassian, now disclose cohort data, and the figure below shows one such chart for Slack Technologies:

   

   Source: Slack Technologies Form S1

By breaking down cohort-specific retention and monetization trends, a cohort chart offers investors visibility into retention and development patterns as a function of subscriber tenure (e.g., does the retention rate get better or worse as subscribers get older), and trends across time, as subscribers stay on the platform. 

Transaction-Based Companies

The guiding principles driving our disclosure recommendations for subscription-based businesses largely extend to transaction-based businesses, with the primary difference being that subscription revenues are replaced with transaction revenues, a number that is not only more difficult to estimate, but one that can vary more widely across customers. The value of the customer base at transaction-based businesses is driven off the activity of these customers, translating into transaction revenues and profits. 

As with subscriber-based businesses, this framework can only be used if the company provides sufficient data from which one can estimate the inputs. Deconstructing this picture, many of the key disclosures track those listed for subscription based companies, including contribution profitability, customer acquisition costs and cohort data. In addition, there are three key additional pieces of information that can be useful in valuing these companies:

1. Active customer count: We replace the notion of a subscriber with that of an “active” customer, which is more suitable for transaction-based businesses. After all, a customer in your platform who never transacts is not affecting value, and one issue that transaction-based companies have struggled with is defining "activity". Wayfair, Amazon, and Airbnb, for example, define an active customer to be one who has placed at least one order over the past 12 months. In contrast, Lyft, Overstock, and many other companies define a customer as active if they placed an order in the past 3 months. 
2. Total orders: In transaction-based companies, the average purchase frequency of active customers can change, often significantly, over time. We need to know the total orders because this further allows us to decompose changes in revenue per active customer into changes in order frequency per active customer and changes in average order value. While some transaction-based businesses disclose this information, including Wayfair, Overstock, Airbnb, and Lyft, this data is notably absent for many others, such as Amazon.
3. Promotional activity: It can be easy to significantly increase purchase activity through enticing targeted promotions, creating the illusion of rapid growth that may not be sustainable over the long run, due to their substantial cost. Since these promotions are often reported as revenue reductions, rather than expenses, the cost of these campaigns are often opaque, to investors. For example, DoorDash did not disclose their total promotional expense during the most recent 6 months in their IPO prospectus, creating substantial uncertainty for investors as to how this may have influenced gross food sales). 

Fintech Companies

In the last decade, we have seen banks, insurance companies and investment firms face disruption from firms in the "fin-tech" space, covering a diverse array of companies in the space. With all of these companies, though, there is (or should be) a lingering concern that part of their value proposition comes from "regulatory arbitrage", i.e., that these disruptions can operate as financial service companies, without the regulatory overlay that constrains these companies, at least in their nascent years. Since this regulatory arbitrage is a mirage, that will be exposed and closed as these fin-tech companies scale up, investors in these companies need more information on:

• Quality/Risk metrics on operating activity: In the aftermath of the 2008 crisis, banks, insurance companies and investment banks have all seen their disclosure requirements increase, but ironically, the young, technology-based companies that have entered this space seem to have escaped this scrutiny. In fact, the absence of a regulatory overlay at these companies makes this oversight even more dangerous, since an online lender that uses a growing loan base as its basis for a higher valuation, but does not report on the default risk in that loan base, is a problem waiting to blow up. It is highly informative for investors to observe the evolution of these measures in the years and quarters leading up to the IPO. Indeed, lenders can be tempted to strategically lower their credit standards to issue more loans (and hence significantly increase revenue through loan-related fees, which are often assessed upfront) to create the illusion of growth at the expense of long-term profitability and trust (since many of these risky loans are likely to default in the future).
• Capital Buffer: It is worth remembering that banks existed prior to the Basel accords, and that the more prudent and long-standing ones learned early on that they needed to set aside a capital buffer to cover unexpected loan losses or other financial shortfalls. In the last century, regulators have replaced these voluntary capital set asides, at banks and insurance companies, with regulatory capital needs, tied (sometimes imperfectly) to the risk in their business portfolios. Many fintech companies have been able to avoid that regulatory burden, largely because they are too small for regulatory concern, but since they are not immune from shocks, they too should be building capital buffers and reporting on the magnitude of these buffers to investors. 

Conclusion

As data becomes easier to collect and access, the demands for data disclosure from different interest groups will only increase over time, as investors, regulators, environmentalists and others continue to add to the list of items that they want disclosed. That will make already bulky disclosures even bulkier, and in our view, less informative. There are three ways to have your cake and eat it too. The first is to allow for increasing customization of disclosure requirements to the firms in question, since requiring all firms to report everything not only results in disclosures becoming data dumps, but also in the obscuring of the disclosures that truly matter. The second is to shift the materiality definition from impact on earnings to impact on value, thus moving the focus from the past to the future. Finally, tying disclosures to a company's characteristics and value stories will limit those stories and create more accountability.

YouTube Video

Papers

1. Going to Pieces: Valuing Users, Subscribers and Customers
2. Initial Public Offerings: Dealing with the Disclosure Dilemma (with Dan McCarthy and Maxime Cohen)

Blog Posts

1. User and Subscriber Businesses: The Good, the Bad and the Ugly!
2. Disclosure Dilemma: When more (data) leads to less (information)

Disclosure Dilemma: When more (data) leads to less (information)!

In the last few decades, as disclosure requirements for publicly traded firms have increased, annual reports and regulatory filings have become heftier. Some of this surge can be attributed to companies becoming more complex and geographically diversified, but much of it can be traced to increased disclosure requirements from accounting rule writers and market regulators. Driven by the belief that more disclosure is always better for investors, each market meltdown and corporate scandal has given rise to new reporting additions. In this post, I look at trends in corporate reporting and filings over time, and why well-meaning attempts to help investors have had the perverse effect of leaving them more confused and lost than ever before.

Time Trends in Reporting

   Publicly traded firms have always had to report their results to their shareholders, but over time, the requirements on what they need to report, and how accessible those reports are to the public (including non-shareholders) has shifted. Until the early 1900s, reporting by public companies was meager, varied widely across firms, and depended largely on the whims of managers, with smaller, closely held firms among the most secretive. Between 1897 and 1905, for instance, Westinghouse Electric & Manufacturing neither published an annual report, not held a shareholder meeting. In the years before the First World War, the demands for more disclosure came from critics of big business, concerned about their market power, but few companies responded. It took the Great Depression for the New York Stock Exchange to wake up to the need for improved and standardized disclosure requirements, and for the government to create a regulatory body, the Securities and Exchange Commission (SEC). The SEC was created by the Securities Act of 1933, which was characterized as "an act to provide full and fair disclosure of the character of the securities sold in interstate and foreign commerce", and augmented by the Securities Exchange Act of 1934, covering secondary trading of securities. Almost in parallel, accounting as a profession found its footing and worked on creating rules that would apply to reporting, at least at publicly traded companies, with GAAP (Generally Accepted Accounting Principles) making its appearance in 1933. In the years since, disclosure requirements have changed and expanded, with companies in foreign markets creating their own rules in IFRS (International Financial Reporting Standards), with many commonalities and a few differences from GAAP. To get a measure of how disclosures have changed over time, I will focus on two filings that companies have been required to make with the SEC for decades. The first is the 10-K, an annual filing that all publicly traded companies have to make, in the United States. The second is the S-1, a prospectus that private companies planning to go public have to file, as a prelude to offering shares to public market investors.

The 10-K (Annual Filing)

    The Securities Exchange Act of 1934 initiated the rule that companies of a certain size and number of shareholders have to file company information with the SEC both annually and quarterly. The threshold levels of company size and shareholder count have changed over time (it currently stands at $10 million in  assets and 2000 shareholders), as have the information requirements for the filing. In the early years, the SEC summarized the company filings in reports to Congress, but the general public and investors had little access to the filings, relying instead on annual reports from the companies, for their information. It was the SEC's institution of an electronic filing system (EDGAR) in 1994 that has made both annual (10-K) and quarterly (10-Q) filings easily and more freely accessible to investors, leveling the playing field.

    I valued my first company in 1981, using an annual report as the basis for financial data, but my usage of 10-Ks did not begin until the 1990s. I have always struggled with both the language and the length of these filings, but I must confess that these struggles have become worse over time. Put simply, there is less and less that I find useful in a 10-K filing, and more verbiage that seems more intended to confuse rather than inform. Let me start with how this filing has evolved at one company, Coca Cola, between 1994 and 2020, using the most simplistic metric that I can think of, i.e., the number of pages in the filing:

Coca Cola Investor Relations

This is clearly anecdotal evidence, and may reflect company-specific factors, but there is evidence to indicate that Coca Cola is not alone in bulking up its SEC filings. In a research paper focused almost entirely on how 10-K disclosures have evolved over time, Dyers, Lang and Stice-Lawrence count not just the words in 10-K filings (one advantage of having electronic filings is that this gets easier), but also what they term redundant, boilerplate and sticky words (see descriptions below chart):

Dyers, Lang and Stice-Lawrence

Redundant words: Number of words in sentence repeated verbatim in other portions of report

Boilerplate words: Words in sentences with 4-word phrases used in at least 75% of all firms' 10Ks

Sticky words: Words in sentences with 8-word phrase used in prior year's 10K

While this paper goes only through 2013, a more updated study suggests that the word count has continued to climb in recent years:

Lesmy, Muchnik & Mugerman

Both studies referenced to above also point to another troubling trend in the 10-K filings, which is that they have become less readable over time. Lesmy, Muchnik and Mugerman use two popular measures of readability, the Gunning-Fog Index and the Flesch-Kincaid readability test on 10-Ks, and find that not only are 10-Ks much less readable than most texts (they use the Corpus of Contemporary English or COCA Academic texts) and the newspapers (they use the financial and general section of The Daily Telegraph, a UK paper), but that the gap is also getting wider:

Lesmy, Muchnik & Mugerman

To be honest, I think that the authors are being charitable in their assessment of 10-Ks, by linking their reading to higher education. The complexity in the filings does not come from using bigger words or advanced language, but from using a mix of legalese, double-talk and buzzwords to leave readers, no matter how educated they are, in a complete fog. Why have 10-Ks become longer and less readable? Dyers, Lang and Stice-Lawrence make a creative attempt to answer this question, by first breaking down the filing information into thirteen topic categories and graphing how 

Dyers, Lang and Stice-Lawrence

After placing the lion’s share of the blame for bloat on the SEC and rule writers,  Dyers et al, also note three topics account not just for much of the verbosity, but also the redundancy, stickiness and lack of readability: risk factors, internal control and fair value/impairment. 

Dyers, Lang and Stice-Lawrence

While the risk factor section may provide employment for lawyers, internal control for auditors and fair value/impairment for accountants, I have always found these sections to be, for the most part, useless, as an investor. The risk factors are legalese that state the obvious, the internal controls section (a special thanks to Sarbanes-Oxley for this add-on) is a self-assessment of management that they are "in control", and the fair value/impairment by accountants happens too late to be helpful to investors; by the time accountants get around to impairing or fairly valuing assets, the rest of the world has moved on. 

The S-1 (Prospectus)

The S-1 is a prospectus filing that companies that plan to go public in the US have to make, and it plays multiple roles, a recording of the company’s financial history, a descriptor of its business models and risks and a planner for its offerings and proceeds. As with the 10-K, the requirements for the prospectus go back to the Securities Exchange Act of 1934, but the disclosure requirements have become more expansive over time. To provide a measure of how much the S-1 has bulked up over time, consider the table below, where I compare the number of pages in the prospectus filings of two high profile companies from each decade, from the 1980s to today:

SEC Filings

Consider two high profile offerings from the 1980s, Apple and Microsoft, and contrast them with the filings from IPOs in more recent years. Apple’s prospectus from 1980 was considered long, running 73 pages, and Microsoft’s prospectus in 1986 was 69 pages long, with the appendices containing the financials. In contrast, Uber’s prospectus in 2019 was 285 pages long, with a separate section of 94 pages for the financial statements and other disclosures, itself an increase on the Facebook prospectus from 2012, which was 150 pages, with 36 pages added on for financial statements and other add-ons. Along the way, prospectuses have become more complex and less readable, and there are three forces that have caused these changes. 

• The first is that the added verbiage on key inputs has made them more difficult to understand, rather than provide clarity. Consider, for instance, the disclosure requirements for share count, which have not changed substantially since the 1980s, but share structures have become more complex at companies, creating more confusion about shares outstanding. Airbnb, in its final prospectus, before its initial public offering asserted that there would 47.36 million class A and 490.89 million class B shares, after its offering, but then added that this share count excluded not only 30.87 million options on class A shares and 13.79 million options on class B shares, but also 37.51 million restricted stock units, subject to service and vesting requirements. While this is technically "disclosure", note that the key question of why restricted stock units are being ignored in share count is unanswered.
• The second is that companies have used the SEC's restrictions on making projections to their advantage, to tell big stories about value, while holding back details. For some companies, a key metric that is emphasized is the total addressable market (TAM), a critical number in determining value, but one that can be stretched to mean whatever you want it to, with little accountability built in. In 2019, Uber claimed that its TAM was $5.2 trillion, counting in all car sales and mass transit in that number, and Airbnb contended that its TAM was $3.4 trillion, five times larger than the entire hotel market's revenues in that year.
• Finally, while most companies, that are on the verge of going public, lose money and burn through cash, they have found creative ways of recomputing or adjusting earnings to make it look like they are making money. Thus, adding back stock-based compensation, capitalizing expenses that are designed to generate growth (like customer acquisition costs) and treating operating expenses as one-time or extraordinary, when they are neither, have become accepted practice.

In sum, prospectuses like 10-Ks have become bigger, more complex and less readable over time, and as with 10-Ks, investors find themselves more adrift than ever before, when trying to price initial public offerings.

The Investor Perspective

As companies disclose more and more, investors should be becoming more informed and valuing/pricing companies should be getting easier, right? In my view, the answer is no, and I think that investors are being hurt by the relentless urge to add more disclosures. I am not the first, nor will I be the last one, arguing that the disclosure demon is out of control, but many of the arguments are framed in terms of the disclosure costs exceeding benefits, but these arguments cede the high ground to disclosure advocates, by accepting their premise that more disclosure is always good for investors and markets. On the contrary, I believe that the push for more disclosure is hurting investors and creating perverse consequences, for many reasons:

1. Information Overload: Is more disclosure always better than less? There are some who believe so, arguing that you always have the option of ignoring the disclosures that you don't want to use, and focusing on the disclosures that you do. Not surprisingly, their views on disclosure tend to be expansive, since as long as someone, somewhere, can find a use for disclosed data, it should be. The research accumulating on information overload suggests that they wrong, and that more data can lead to less rational and reasoned decision for three reasons. First, the human mind is easily distracted and as filings get longer and more rambling, it is easy to lose sight of the mission on hand and get lost on tangents. Second, as disclosures mount up on multiple dimensions, it is worth remembering that not all details matter equally. Put simply, sifting though the details that matter from the many data points that do not becomes more difficult, when you have 250 pages in a 10-K or S-1 filing. Third, behavioral research indicates that as people are inundated with more data, their minds often shut down and they revert back to "mental short cuts", simplistic decision making tools that throw out much or all of the data designed to help them on that decision. Is it any surprise that potential investors in an IPO price it based upon a user count or the size of the total accessible markets, choosing to ignore the tens of pages spent describing the risk profile or business structures of a company? 
2. Feedback loop: As companies are increasingly required to disclose details about corporate governance and environmental practices in their filings, some of them have decided to use this as an excuse for adopting unfair rules and practices, and then disclosing them, operating on the precept that sins, once confessed, are forgiven.. This trend has been particularly true in corporate governance, where we have seen a surge in companies with shares with different voting rights and captive boards, since the advent of rules mandating corporate governance disclosure. For a particularly egregious example of overreach, with full disclosure, take a look at WeWork's prospectus and especially the rules that it explicitly laid out for CEO succession.
3. Cater to your audience: Company disclose data to multiple groups, to governments to meet regulatory requirements and for taxes, to consumers about the goods and services they they sell, to their bankers about loan obligations due and to shareholders about their overeat financial performance. Rule writers on disclosure sometimes seem to forget that each of these groups need different information, and trying to meet all their needs in one disclosure is a disservice to all of them.  It is worth remembering that the reason that we have 10-Ks and S-1s at companies is for shareholders, interested in investing in the company, not regulators, consumers, accountants or lawyers. That said, it is also worth remembering that not everyone investing in a  company is an investor and that many are traders. Drawing on a contrast that I have used many times before, investors are interested in the value of a stock, which, in turn, is determined by cash flows, growth and risk, and buying stocks that they believe trade at a price less than the value. Traders, on the other hand, have little interested in fundamentals, focusing  instead on mood and momentum, and how those forces can lead to prices increase.
   
   Much of the regulatory disclosure has been focused on what investors need to value companies, albeit often with an accounting bias. However, there are for more traders than investors in the market, and their information needs are often simpler and more basic than investors. Put simply, they want metrics that are uniformly estimated across companies and can be used in pricing, whether it be on revenues or earnings. With young companies, they may even prefer to use user or subscriber counts over any numbers on the financial statements. 
4. Make it about the future, not just the past: While I don't think that anyone would dispute the contention that investing is always about the future, not the past, the regulatory disclosure rules in the US and elsewhere seem to ignore it. In fact, much of regulatory rule making is about forcing companies to reveal what has happened in their past, and while I would not take issue with that, I do take issue with the restrictions that disclosure laws put on forecasting the future. With the prospectus, for instance, I find it odd that companies are tightly constrained on what they can say about their future, but that they can wax eloquently about what has happened in the past. Given that much or all of the value of these companies comes from their future growth, what is the harm in allowing companies to be more explicit about their beliefs for the future? Is it possible that they will exaggerate their strengths and minimize their weaknesses? Of course, but investors know that already and can make their own corrections to these forecasts. More importantly, stopping companies from making these forecasts does not block others (analysts, market experts, sales people), often less scrupulous and less informed than the companies, from making their own forecasts.
5. Mission Confusion: Should disclosures be primarily directed at informing investors or protecting them? While it is easy to argue that you should do both, regulators have to decide which mission takes primacy, and from my perspective, it looks like protection is often given the lead position. Not surprisingly, it follows that disclosures become risk averse and lawyerly, and that companies follow templates that are designed to keep them on the straight and narrow, rather than ones that are more creative and focused on telling their business stories to investors.

Disclosure Fixes

The nature of dysfunctional processes is that they create vested interests that benefit from the dysfunction, and the disclosure process is no exception. I am under no illusions that what I am suggesting as guiding principles on disclosure will be quickly dismissed by the rule writers, but I am okay with that. 

1. Less is more: I do think that most regulators and investors are aware that we are well past the point of diminishing returns on more disclosure, and that disclosures need slimming down. That is easier said than done, since it is far more difficult to pull back disclosure requirements than it is to add them. There are three suggestions that I would make, though there will be interest groups that will push back on each one. First, the risk profile, internal control and fair value/impairment sections need to be drastically reduced, and one way to prune is to ask investors (not accountants or lawyers) whether they find these disclosures useful. A more objective test of the value to investors of these disclosures is to look at the market price reaction to them, and if there is none, to assume that investors are not helped. (If you apply that test on goodwill impairment, you would not only save dozens of pages in disclosures, but also millions of dollars that are wasted every year on this absolutely useless exercise) Second, I would use a rule that has stood me in good stead, when trying to keep my clothes from overflowing my limited closet space, in the disclosure space. When a new disclosure is added, an old one of equivalent length has to be eliminated, which of course will set up a contest between competing needs, but that is healthy. Third, any disclosures that draw disproportionately on boilerplate language (risk sections are notorious for this) need to be shrunk or even eliminated.
2. Don't forget traders: Almost all of the disclosure, as written today, is focused on investor needs for information. Thus, there is almost no attention paid to the pricing metric being used in a sector, and to peer group comparisons. Rather than adopt a laissez fare approach, and let companies choose to provide these numbers, often on their own terms and with little oversight, it may make more sense that disclosure requirements on pricing and peer groups be more specific, allowing for different metrics in different sectors. Just to provide one illustration, I believe that the prospectus for a company aspiring to go public should include details of all past venture capital rounds, with imputed pricing in each round. While investors may not care much about this data, it is central for traders who are interested in pricing the company. 
3. Let companies tell stories and make projections: The idea that allowing companies to make projections and fill in details about what they see in their future will lead to misleading and even fraudulent claims does not give potential buyers of its shares enough credit for being able to make their own judgments.With the S-1, the disclosure status quo is letting young companies off the hook, since they can provide the outlines of a story (TAM, multitude of users, growth in subscribers) without filling in the details that matter (market share, subscriber renewal and pricing).
4. With triggered disclosures: To the extent that some companies want to tell stories built around non-financial metrics like users, subscribers, customers or download, let them. That said, rather than requiring all companies to reveal unit economics data, given the misgivings we have about disclosures becoming denser and longer, we would argue for triggered disclosure, where any company that wants to build its story around its user or subscriber numbers (Uber, Netflix and Airbnb) will have to then provide full information about these users and subscribers (user acquisition costs, churn/renewal rates, cohort tables etc.)

I hope that we can keep these principles in mind, as we embark on what is now almost certain to become the next big disclosure debate, which is what companies should be required to report on environmental, social and governance (ESG) issues. You are probably aware of my dyspeptic views of the entire ESG phenomenon, and I am wary about the disclosure aspects as well. If we let ESG measurement services and consultants become the arbiters of what aspects of goodness and badness need to be measured and how, we are going to see disclosures become even more complex and lengthy than they already are. If you truly want companies to be good corporate citizens, you should fight to keep these disclosures in financial filings limited to only those ESG dimensions that are material, written in plain language (rather than in ESG buzzwords) and focused on specifics, rather than generalities. Speaking from the perspective of a teacher, put a word limit on these disclosures, take points off for obfuscation and then think of what existing disclosures should be removed to make room for it!

YouTube Video

Company Filings

1. EDGAR Company Filings (US companies)
2. Companies House (UK company filings)

Research

1. The Evolution of 10-K Textual Disclosure: Evidence from Latent Dirichlet Allocation (Dyers, Lang & Stice-Lawrence)
2. Doyoureadme? (Lesmy, Muchnik and Mugerman)