Earnings Guidance : the Current State of Play, a Follow-up Discussion of Earnings Guidance and Other Forward-looking Information Provided to Investors

Earnings Guidance: The Current State of Play A Follow-up Discussion of Earnings Guidance and Other Forward-looking Information Provided to Investors

June 2009

Financial Executives Research Foundation, Inc. (FERF) would like to acknowledge and thank the following for their longstanding support and generosity:

Platinum major gift | $50,000 + Exxon Mobil Corporation Microsoft Corporation

Gold president’s circle | $10,000 - $14,999 Abbott Laboratories, Inc. The Coca-Cola Company Dow Chemical Company General Electric Company H.S.Grace & Company, Inc.

Silver president’s circle | $5,000 - $9,999 ALCOA Foundation Cargill, Incorporated Cisco Systems Comcast Corporation Corning Incorporated Credit Suisse Cummins Inc. CVS Corporation Dell Inc.

2

E. I. du Pont de Nemours El Paso Corporation Eli Lilly and Company General Motors Corporation Halliburton Company The Hershey Company Hewlett-Packard Company IBM Corporation Infogix, Inc. Johnson & Johnson Kimberly-Clark Corporation Medtronic, Inc. Motorola, Inc. Pfizer Inc. Procter & Gamble Co. Safeway Inc. Siemens AG Sony Corporation of America Tenneco Time Warner Inc. Tyco International United Technologies Corp. Verizon Foundation

Table of Contents

Foreword

2

Introduction

3

Long-term Focus: What has changed since our last report?

4

Leading Thinkers Speak Out Judith Samuelson, Executive Director, The Aspen Institute Kurt Schacht, Managing Director, CFA Institute Centre for Financial Market Integrity Michael R. Young, Partner, Willkie Farr & Gallagher William Donaldson, Chair, CED Corporate Governance Subcommittee

5 6 8 10 12

The Case at Hand: Company Perspectives

14

Conclusion

21

Appendices A. In Memoriam: An Interview with Mr. James Cantalupo B. Facing an Unpredictable World: How to Change Earnings Guidance Practices by Broc Romanek C. Apples to Apples: A Template for Reporting Quarterly Earnings, by the CFA Center for Financial Market Integrity D. Long-Term Value Creation: Guiding Principles for Corporations and Investors, The Aspen Institute’s Business and Society Program

22 23 24 27 35

Disclaimer These materials and the information contained herein are provided by Deloitte and are intended to provide general information on a particular subject or subjects and are not an exhaustive treatment of such subject(s). Accordingly, the information in these materials is not intended to constitute accounting, tax, legal, investment, consulting, or other professional advice or services. The information is not intended to be relied upon as the sole basis for any decision which may affect you or your business. Before making any decision or taking any action that might affect your personal finances or business, you should consult a qualified professional adviser. These materials and the information contained therein are provided as is, and Deloitte makes no express or implied representations or warranties regarding these materials or the information contained therein. Without limiting the foregoing, Deloitte does not warrant that the materials or information contained therein will be error-free or will meet any particular criteria of performance or quality. Deloitte expressly disclaims all implied warranties, including, without limitation, warranties of merchantability, title, fitness for a particular purpose, noninfringement, compatibility, security, and accuracy. Your use of these materials and information contained therein is at your own risk, and you assume full responsibility and risk of loss resulting from the use thereof. Deloitte will not be liable for any special, indirect, incidental, consequential, or punitive damages or any other damages whatsoever, whether in an action of contract, statute, tort (including, without limitation, negligence), or otherwise, relating to the use of these materials or the information contained therein. If any of the foregoing is not fully enforceable for any reason, the remainder shall nonetheless continue to apply. Earnings Guidance: The Current State of Play 3 Earnings Guidance: The Current State of Play 3

Foreword Following many high-profile corporate scandals and failures in the early part of the new millennium, in 2003 Deloitte LLP (Deloitte) and Financial Executives Research Foundation collaborated to publish “Meeting the Street,” which explored trends and implications related to the corporate practice of providing forward-looking earnings guidance. What has changed since then? In the recent past, we have seen corporate failures of an unimaginable magnitude and an even greater collapse of public trust in capital markets. While there is no one factor to blame for the current crisis, many senior financial executives are again weighing the benefits and risks associated with publishing forward-looking earnings guidance. This report updates corporate leaders on what has changed with respect to corporate guidance practices. Our hope is that companies will continue to evaluate their practices in this area, and that the information presented in this report prove helpful.

Robert J. Kueppers Deputy Chief Executive Officer Deloitte LLP

2

Nicole M. Sandford Partner, Center for Corporate Governance Deloitte & Touche LLP

Thomas Thompson, Jr. Research Associate Financial Executives Research Foundation

Introduction In November 2003, Deloitte, in association with Financial Executives Research Foundation, released an executive report entitled, “Meeting the Street: A Discussion of Earnings and Other Guidance Provided to Investors”. Based on a Deloitte survey and interviews with a group of corporate and business leaders, the report examined the practice of providing analysts and investors with forward-looking earnings guidance. The report noted that some organizations, regulators, and investors believed that by focusing attention on meeting earnings guidance — in particular, specific EPS or other earnings targets — management may find itself distracted from the company’s long-term goals. The impact of the “meeting the street” mentality on corporate decision-making, and in particular corporate fraud, was also explored. What has changed since 2003? The 24/7 availability of a growing information stream has increased the speed and reduced the reaction time of today’s markets, which may be putting additional pressure on executives to think and act with a short-term bias. Did the focus on short-term, forward-looking earnings guidance and the pressure to meet that guidance contribute to what some observers have called the biggest financial crisis since the Great Depression? Some would argue that it did and that it exacerbated the market’s fall. Our earlier report concluded that there was no one-sizefits-all answer when it came to what forward-looking information should be provided to the public. While that remains true, momentum may be mounting for a movement away from specific quarterly earnings targets. This report provides a comprehensive look at current corporate practices related to forward-looking information. In addition, the authors have attempted to create a compendium of research and tools that boards and executives can use to help guide policy making regarding forward-looking information provided to investors. Our hope is that companies will continue to evaluate their practices in this area and that the information presented in this report proves helpful. The key takeaways are that: • Corporate management and boards should be mindful of the risks and benefits associated with the practice of providing specific earning targets to the market. • Despite the recent economic downturn, most companies have made only marginal changes to their guidance policies.

• Managers develop their communication program to fit what they think analysts want; however many analysts say they want companies to move away from providing specific earnings targets. Direct input from the company’s investors can be helpful in developing meaningful communications. • 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. • Companies may want to reconsider their current practices and determine the real benchmarks of their success. This should help identify other metrics to demonstrate performance and communicate progress. • Boards of directors should insist on a long-term focus that aligns with the company’s objectives and strategy over a more extended horizon, rather than a short-term focus on share price gains. • In deciding whether or not to provide earnings guidance, management should consider: – The ability to forecast performance – The appetite for share price volatility – Industry practices regarding earnings estimates – The appropriate communication of any changes in guidance policies. In this report, we distinguish between forward-looking information and earnings guidance/earnings targets. In performing our research, we discovered that these terms are not always interpreted in the same way. Therefore, it may be useful to define what is meant by each in the context of this report: • At the broadest level, forward-looking information is meant to describe both financial and nonfinancial data provided by the company to the investor and analyst community. This can range from strategic narratives to specific EPS targets. This report may distinguish between financial and nonfinancial forward-looking information. • At a narrower level, we define earnings targets or earnings guidance as specific, quantitative values related to future earnings. The most common example would be estimates of earnings per share for future quarterly or annual periods; however, companies often provide targets for specific components of earnings.

Earnings Guidance: The Current State of Play

3

Long-term focus: What has changed since our last report? The practice of providing forward-looking information, including specific earnings targets, became routine during the late 1990s after Congress passed the Safe Harbor law that protected companies from legal liability in performance forecasts. As a result, the number of firms providing guidance increased from 92 in 1994 to approximately 1,200 by 20011. However, in unsteady economic times, the ability of a company to predict future performance becomes more difficult. As a result, a number of large companies have eliminated or significantly scaled back their practices related to providing forward-looking earnings targets. Some companies, like Coca-Cola, AT&T, McDonald’s, Progressive, and Gillette discontinued, or reduced the frequency of, earnings guidance before our 2003 report. Other notable companies that have followed suit include General Electric, Best Buy, Citigroup, Dell, and Motorola. However, many companies have made no change in this area, and still generally view the practice of providing earnings guidance either positively or as a market necessity. According to a 2009 survey by the National Investor Relations Institute (NIRI)2, there was a relatively modest four percent decrease in the number of companies that provide earnings-per-share guidance (60% in 2009 versus 64% percent in 2008). The number of companies providing other financial guidance showed a similar decrease (from 86% to 82%). More telling than the statistics themselves was the rationale behind a company’s policy on earnings-per-share guidance. Companies that provide earnings guidance3 said that they do so for the following reasons (more than one answer could be selected): • To ensure sell-side consensus and market expectations are reasonable (84%) • Because the company has better visibility than outsiders (46%) • To try to limit stock volatility (46%) • To satisfy investor or sell-side analyst requests (44%) On the flip side, companies that chose not to provide earnings-per-share guidance had done so (more than one answer could be selected): • To focus on long-term company performance (43%) • Because of low earnings visibility (41%) • As a reflection of management’s philosophy (41%)

The data from this year’s survey show that despite the recent extraordinary economic downturn, survey respondents’ companies have generally made only marginal changes to their guidance policies, as opposed to dramatic ones. Jeffrey Morgan, president and chief executive officer of the National Investor Relations Institute, offered his insights on this year’s survey. "We took a detailed look at three core components of guidance: the measures on which the company chooses to provide guidance; the periodicity of guidance, or the timeframe the estimates cover; and the frequency of guidance communications, or how often guidance, updates, or reiterations are provided. In what is perhaps a surprise for those participating in the public debate about the merits of earnings guidance, we found that the periodicity most commonly used for all types of earnings guidance is annual, and the most common frequency of earnings guidance communications is quarterly." “This distinction between guidance periodicity and frequency is an important nuance, and very different from companies simply providing quarterly earnings-per-share forecasts. What this says is that companies are providing a forecast for a point in time one year forward rather than for each quarter over the next year. And they are updating that annual forecast when they report their quarterly results. This is very relevant to the public commentary concerning public company forward-looking guidance practices and the increasingly short-term focus of the marketplace. We believe it represents the evolution of strictly quarterly guidance practices over the past several years.” Respondents’ personal opinions on guidance practices, as measured in a series of qualitative questions in the NIRI study, were nearly identical to the results from the prior year. This is consistent with the results of an informal poll of participants in a May 2009 Deloitte webcast.4 A full 39% of the 1,125 respondents viewed the practice of providing forward-looking earnings guidance as positive, with 24% viewing such practices as negative. The rest were either neutral or answered that they didn’t know.

“The Decline of Earnings Guidance”; Economist.com, April 2006 ”Public Company Forward-Looking Guidance Practices in 2009”; National Investor Relations Institute Executive Alert, May 18, 2009 3 NIRI defines “earnings guidance” in the introduction to its annual survey to generally mean earnings-per-share targets. 4 This webcast was part of Deloitte’s “Dbriefs for Financial Executives” series. The participants were predominately finance and accounting professionals. 1 2

4

Leading Thinkers Speak Out Despite the relative slow pace of change in corporate practices, a number of prominent organizations have published reports in recent years that urge companies to reconsider the types of forward-looking information provided to investors. Each report, in its own way, calls for the use of alternative forms of corporate performance information. Here we summarize the findings and recommendations of several seminal works, and provide the results of recent interviews with representatives of the organizations responsible for each. The interviewees offered their thoughts and personal perspectives on the practice of providing forward-looking guidance, including specific earnings targets.

Earnings Guidance: The Current State of Play

5

A. Long-Term Value Creation: Guiding Principles for Corporations and Investors In 2007, The Aspen Institute published “Long-Term Value Creation: Guiding Principles for Corporations and Investors” (known widely as the “Aspen Principles”). The Principles were developed by the business and investor community, and views from corporate leaders, institutional investors, labor, academics, and professional advisors were considered in the development of the final set of Principles. T he Aspen Principles address three equally important factors in sustainable long-term value creation: metrics, communications, and compensation. At the heart of the Principles is the belief that a focus on short-term performance runs counter to the long-term success of a corporation and society. Specific recommendations regarding each are provided, and can be briefly summarized as follows: 1. Define metrics of long-term value creation Companies and investors oriented for the long-term use forward-looking incentives and measures of performance that are linked to a robust and credible business strategy. Long-term oriented firms are ‘built to last,’ and expect to create value over five years and beyond, although individual metrics may have shorter time horizons. The goal of such metrics is to maximize future value (even at the expense of lower near-term earnings) and to provide the investment community and other key stakeholders the information they need to make better decisions about long-term value. 2. Focus corporate-investor communication around long-term metrics Long-term oriented companies and investors are vigilant about aligning communications with long-term performance metrics. They find appropriate ways to support an amplified voice for long-term investors and make explicit efforts to communicate with long-term investors. 3. Align company and investor compensation policies with long-term metrics Compensation at long-term oriented firms is based on long-term performance, is principled, and is understandable. Operating companies align senior executives’ compensation and incentives with business strategy and long-term metrics. Institutional investors assure that performance measures and compensation policies for their executives and investment managers emphasize long-term value creation.5 A number of prominent companies and institutional investors have adopted the philosophy embodied in the Principles, which are provided in their entirety as Appendix D.

Judith Samuelson, Executive Director, The Aspen Institute Judith Samuelson is the executive director of the Aspen Institute’s Business and Society Program (www.aspenbsp.org). She created the policy program, which is dedicated to developing leaders for a sustainable global society, for the Aspen Institute in 1998. Her experience spans the business, government, and nonprofit sectors. Judith joined the Ford Foundation in 1989 and served through 1996 as the director of the Office of Program-Related Investments, the foundation’s social investment fund. In 1994, she helped launch the foundation’s Corporate Involvement Initiative, a comprehensive effort to encourage private-nonprofit partnerships and facilitate business opportunities with broad social benefits.

In the time since the Aspen Principles were first published, what has the reaction been? In June [2009], it [was] two years since the Aspen Principles were published. We started with a small but important core group of companies and trade associations which coalesced around a set of principles and practices that would achieve a better balance between short- and long-term focus. The Principles span identifying the right metrics, how to communicate with Wall Street and, importantly, how to assure that incentive and compensation systems are fully aligned with the long-term view. Since then, we have earned the acknowledgment and support of a number of other organizations, including the Center for Audit Quality (CAQ) and the U.S. Chamber

of Commerce. Our most recent signatory is Casey Family Programs, our first foundation, which has signed as an institutional investor with a $2.5 billion endowment. The Principles have been featured in Business Week, the Wall Street Journal and even the report of the TARP oversight committee set up by Congress. We continue to respond to requests for information from a number of Fortune 300 companies that are exploring practices that the Principles promote. In December 2008, General Electric announced it will no longer provide quarterly earnings guidance and Microsoft followed suit this last quarter. Dropping the practice of quarterly forecasts is an important principle of practice.

“Long-Term Value Creation: Guiding Principles for Corporations and Investors”, The Aspen Institute Business and Society Program, 2008

5 

6

Companies today are now asking, “What are the best ways to communicate our progress?” We understand that Talisman Energy, a Canadian public company, has developed a set of metrics to measure non-financial as well as financial performance, in both the short and long-term horizons. We applaud this initiative because companies learn from the best examples of others. Metrics can be specific to individual industries and firms, and we want to look into this over the next nine months. Our most important work is still ahead of us. The Principles were a start, drawn from a dozen different sources. We have built a platform that allows us to create further dialogue. There is definitely heightened interest in shorttermism and its consequences. Everyone from Warren Buffett to President Obama is talking about the need for long-term focus. But we are in a time of transition; we hope the new administration will provide space to experiment. Are there lessons to be learned from the credit crisis that speak to the Aspen Principles? The big lesson from the credit crisis is that the current system is designed perfectly to generate the kinds of results we’ve seen. We have seen how the focus on earnings per share can drive outrageous behavior, because people will produce what they are paid to produce. The credit crisis has shown us how short-term focused we can be. If we want a different result, we have to design a different system. And that means changing behavior for both companies and investors. Both have work to do to create a better system. How do the Aspen Principles address the issue of earnings guidance – the pros, cons, and unintended consequences? Interestingly, when the Principles were first released, the recommendation against providing quarterly earnings guidance became the major focus by the business press. That is all they wanted to talk about. Over the past year and a half, we’ve been collaborating with several other organizations (including CFA Institute) that have taken a stand similar to ours in favor of moving away from quarterly EPS toward a more comprehensive approach. We think companies will start to move in this direction as well—and in fact that shift is now taking place—GE and Microsoft are great examples of the trend.

compelled to make a quarterly projection. But once the analysts adjust to a new system that includes longer-term metrics and provides broader context, we think they’ll start to have a much better understanding of what’s really driving each business. Can you give some examples on how your sponsoring corporations have implemented the Principles? It’s important to note that many of our original signatories were already well in line with the provisions of the Principles, so in many ways, they were highlighting existing leadership practices within their firms. In addition, we know that Pfizer is experimenting with new models of investor communications. For example, in October 2007, Pfizer’s Board of Directors met with its top 30 largest investors to discuss what information would be important to share. Though this does not seem particularly revolutionary, it was a first meeting of this kind and received a fair amount of attention in the press. There is much room for innovation here. As I mentioned, Talisman Energy has also developed five focus areas on which it evaluates itself on both a short- and long-term horizon, including financial and non-financial information. We know that other companies are also experimenting with forward-looking metrics. Xerox handed the Aspen Principles to their compensation committee as a guide; Fred Cook, compensation consultant, has begun to use these Principles in communications with his clients. If you were the CFO of a public company, how would you be thinking about the kinds of forward-looking financial information to be provided to the analyst/ investor community? The CFO is the company’s point person for its metrics, which we believe should include more than just financial metrics, but all indicators for how value is being created and sustained. After all, many legal/reputational/operational risks and opportunities will show up in non-financials earlier than they will in financial information, such as employee engagement scores, customer loyalty ratings, community and public opinion of a company or industry, satisfactory relationships with regulators, etc.

We think that companies recognize that a focus on earnings per share is a big time sink; to spend a lot of energy managing to that EPS metric does not take them where they want to go.

If I were a CFO, I would step back and ask, “How do we create value internally?” I would want to have a clear understanding of the drivers of long-term success, and I would want to make sure that I could communicate the metrics of such long-term drivers to the market.

Companies should instead ask themselves, “What are the real benchmarks of our success? What values are we trying to create and maintain? How do we know that we are moving in the right direction? What are the early warning systems that we may be off track?” Whether its employee morale, customer loyalty or relations with suppliers or host communities, these benchmarks can help drive change within their firms.

An article appeared in the Harvard Business Review years ago that described early predictors of value, such as customer loyalty, employee engagement, and corporate reputation. If I were a CFO, I would want to know what those early predictors of value were for my company and the industries in which I played—and make sure that I am telling my value-creation story in a compelling way that also provides a degree of comparability for my investors and analysts.

The unintended consequences of not providing earnings forecasts may include confusion among analysts, who may not know what to say about a given company, but feel

Unfortunately, the media is focused on what can be described in 30 seconds or less. I would ask why I, as the CFO, have to play that game. Earnings Guidance: The Current State of Play

7

B. Breaking the Short-Term Cycle: Discussion and Recommendations on How Corporate Leaders, Asset Managers, Investors, and Analysts Can Refocus on LongTerm Value In 2006, the CFA Center for Financial Market Integrity (the “CFA Institute”) and the Business Roundtable Institute for Corporate Ethics co-sponsored the publication of this report based on input from various public symposia held in 2005. Representing an unprecedented collaboration by the analyst community and chief executives, the report findings may have been surprising to some. The analyst community—the supposed benefactors of the forward-looking earnings guidance provided by corporations—did not universally support the prevailing practices adopted by U.S. companies. In fact, the report concludes that “the obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns, and impeding efforts to strengthen corporate governance.” The report included a number of specific recommendations, excerpted below. In 2007, the CFA Institute published a sample policy for providing earnings guidance, which is reproduced as Appendix C. Summary of recommendations Corporate leaders, asset managers, investors, and analysts should: 1. Reform earnings guidance practices: All groups should reconsider the benefits and consequences of providing and relying upon focused, quarterly earnings guidance and each group’s involvement in the “earnings guidance game.” 2. Develop long-term incentives across the board: Compensation for corporate executives and asset managers should be structured to achieve long-term strategic and value-creation goals. 3. Demonstrate leadership in shifting the focus to long-term value creation. 4. Improve communications and transparency: More meaningful, and potentially more frequent, communications about company strategy and long-term value drivers can lessen the financial community’s dependence on earnings guidance. 5. Promote broad education of all market participants about the benefits of long-term thinking and the costs of short-term thinking.

Kurt Schacht, Managing Director, CFA Institute Centre for Financial Market Integrity Kurt N. Schacht, JD, CFA, is the managing director of the CFA Institute Centre for Financial Market Integrity. He is responsible for all aspects of the Centre’s efforts to develop, promulgate, and maintain the highest ethical standards for the investment community. He directs the Centre’s efforts to represent the views of investment professionals to standard setters, regulatory authorities, and legislative bodies worldwide on issues that affect the practice of financial analysis and investment management, education, and licensing requirements for investment professionals, and the efficiency of global financial markets. Prior to joining CFA Institute, Mr. Schacht has been involved in the investment management business since 1990, serving as chief operating officer for a retail mutual complex, general counsel and COO for a Manhattan-based hedge fund, and as chief legal officer for the State of Wisconsin Investment Board (SWIB). Mr. Schacht is a member of the U.S. Securities and Exchange Commission’s Investor Advisory Committee.

Why has the analyst community taken up this cause? We believe that analysts need to do their own analysis as opposed to simply taking quarterly guidance as a shortcut. And, we have heard repeatedly from companies that say many analysts are lazy and they (the companies) need to spoon-feed them quarterly estimates. The CFA Institute has conducted a number of surveys of its membership, and the results consistently confirm that the majority of our members who respond want companies to move away from providing specific earnings targets. Companies often don’t understand what good analysts use the data for – as a check against their own analysis. It is hard to 8

understand how companies have real visibility into the future – and that has probably never been truer than in this environment. There is no denying that the rapid availability of information and technology has caused a shift in the market in recent history. A trading mentality has been perpetuated. We encourage investors to recognize that a more prudent approach takes into account the long-term prospects of the company. Is a 90-day period relevant to what long-term investors should care about? We don’t think so.

How did we get here? Most managers we have talked to have developed their communication program to fit what they think analysts want, and therefore have focused on the short-term, quarterly earnings targets in many cases. As discussed, we don’t have any empirical evidence that this perception matches the wants or needs of the broader analyst community. Companies also fear that analysts, left to their own devices won’t get “close enough” to actual performance and that will increase volatility. It is true that there could be a temporary volatility impact, but once the analyst community understands the drivers of corporate performance and trusts the quality of information that is provided, the temporary volatility should disappear. What are the first steps companies should take in reassessing what guidance is being provided? First, understand what kind of investors you want to attract. If you want to attract short-term investors—the “trading crowd”—then providing quarterly guidance and managing and communicating to the short-term is your fate. If you want to attract long-term investors, then you need to communicate to the long-term. Once you are comfortable with your long-term plans, it is important to reach out to those investors. Explain what the company wants to do, and why. Perhaps even ask them what kinds of additional long-term information they would like to receive. On that point, I have a few suggestions about what that additional information might look like. We published a template for quarterly information (see Appendix C) that companies will find useful. At a minimum, companies should shift from quarterly to annual targets. We do not support earnings guidance generally; but most definitely quarterly guidance has led to an unhealthy focus on the short term on the part of public companies.

Also, we support companies taking a close look at compensation structure. To the extent that compensation is driven by EPS and meeting quarterly guidance, it is an opportune time to reexamine those practices. Stock incentives are entirely appropriate, but pay attention to how they are structured and make sure plans focus on longer-term performance. Who should lead this within the company? Of course the CEO can—and should—take the lead. But in practice, the board may need to take the first step. The board, and in particular the audit committee, sets the tone of the organization regarding the quality of financial reporting. For far too long, boards have tolerated a culture that supports a focus on the stock price from one period to the next. A visionary board needs to say to management, “We don’t want to play this game quarterly anymore, and neither should you. We can tolerate some short-term volatility if it helps you to refocus on the long-term. Focus on making this franchise great over the long haul.” The CFO also has an important role to play. He or she has to be willing to convey the message of long-term focus and not buckle to the whim of short-term investors demanding short-term information. They must be willing to stand up and “retrain” their investor base as needed. The message is, the company intends to provide you with relevant quarterly information about the long-term drivers and prospects for our company. As a company and as a management team, we want to get off this quarterly guidance treadmill once and for all.

Of course, EPS is only one small factor. It is a short-term value measure and easily manipulated. There is so much more to understand and focus on with any company. We are encouraging companies to provide—on a quarterly basis—a qualitative discussion of the drivers of long-term corporate performance. That information will help identify the data investors need to help measure the company’s prospects and expectations for performance against those drivers.

Earnings Guidance: The Current State of Play

9

C. Accounting Irregularities and Financial Fraud: A Corporate Governance Guide Republished in 2006, many consider this book to be the definitive resource on the nature, causes, and appropriate response to corporate fraudulent behavior. While the manifestations of financial fraud can range from the surprisingly simple to extremely complex, the author, Michael Young, provides his views on the common factors. The book creates a roadmap for boards and executives interested in preventing and detecting financial fraud. Mr. Young also provides perspectives on the future of financial reporting.

Michael R. Young, Partner, Willkie Farr & Gallagher Michael R. Young is a senior partner of the New York law firm of Willkie Farr & Gallagher. Mr. Young is a litigator specializing in securities and financial reporting. He has testified in hearings before the Senate Banking Committee’s Subcommittee on Securities, the Blue Ribbon Committee on Improving the Effectiveness of Audit Committees of the NYSE and Nasdaq, and the Panel on Audit Effectiveness of the Public Oversight Board. Mr. Young is a graduate of Allegheny College and the Duke University School of Law.

What are the particular dangers you have seen in providing forward-looking earnings information to the public? The main danger today starts with the public’s unquenchable thirst for financial information. Forwardlooking information is often perceived to be the equivalent of actual results, and people may inadvisably accept forward-looking information as more concrete than it can be. There are two problems with forward-looking information: 1. Financial results can be very difficult to predict. 2. Once the numbers are out there in public, they can be hard to correct. These problems can create challenges for companies that provide forward-looking information. Because it can be awkward to try to correct the numbers that have already been provided to the public, pressure may trickle down from senior management to accounting, and the accountants may be tempted to “manage” the actual results. This has the potential to give rise to accounting improprieties and eventually restatements. Someone recently asked me, “Mike, you are involved in so many accounting problem cases. How do you keep the facts straight?” I responded that it’s not too tough because the facts are all the same. It is the same scenario over and over again—just change the dates and the names of the companies. Fraudulent financial reporting, at least over the past ten years, has almost always been about managing to earnings targets. 10

Have there been many class-action lawsuits filed against companies that miss earnings estimates? It is the case that a sharp and significant drop in stock price often gets the attention of the plaintiff law firms. But that isn’t really where the action is today. Tort reform of the 1990s has largely worked to offer protections for forwardlooking information. Courts have generally applied it as intended, and therefore fewer lawsuits are out there from forward-looking information. If plaintiff attorneys look at the reasons for the stock drop and determine that it is a result of missing guidance, they frequently won’t take the case. In the past, overly optimistic Wall Street expectations often led to financial misreporting. Is this still a problem today? The good news it is less of a problem. The bad news is that it is less of a problem because other issues have displaced it. These days, we see financial reports that often convey bad news, really bad news, or bankruptcy. In a sense, the problem of attaining overly optimistic expectations is a problem of the past—but history can be expected to repeat itself given some time. The bigger challenge today is fair value accounting— specifically, building models for reliable value/estimates and disclosure. There are a lot of benefits to fair value accounting, most notably giving investors what they appear to want. But, markets are volatile, and that creates another impediment to earnings predictions.

Does that mean a company should not provide any forward-looking information? Never say never, but companies should appreciate the downside of trying to reliably predict the future and the downside of trying to correct when your predictions fail to materialize. A company that balances the benefits and the costs might choose to opt for accurate, robust, transparent, and timely historical information and let investors draw their own conclusions about what that means for the future. In our first report, you talked about the promise of more “real-time” reporting as an alternative to guidance practices. Have you seen a trend toward real-time financial reporting since then? Absolutely. The most visible evidence is the corporate response to the sub-prime crisis. Since the summer of 2007, problems related to sub-prime mortgages have received a lot of attention. Because of the dislocations in the market, companies have wanted to get the bad news out fast, resulting in the accelerated reporting of bad news. This response has taken everyone towards real-time information. Is there a downside to this movement toward realtime financial reporting? There is, and again we saw it in the dislocation of the credit markets. In some circumstances, reporting accurate historical results is challenging, particularly related to fair value accounting. The challenge is that you want to get up-to-date information to the financial community fast, but if you’re in an environment where there are not observable markets, providing reliable information fast can be tough. So there is a tension between the desire to provide updated information quickly and the desire to provide sufficiently reliable information. We may continue to see audits shift away from data assurance and towards systems assurance. As the need for real-time information increases, we can either let the audit process slow down the release of information, or the audit process can continue to shift towards systems—such as those around internal controls.

What are the regulatory considerations if a company were to decide to provide more frequent historical information? A big one is the risk of being second-guessed on highly judgmental issues by governmental authorities. That includes the SEC, but also the Department of Justice. The unfortunate reality is that a company should assume that, under certain circumstances, its judgments about aspects of its financial reporting will be second guessed with the benefit of hindsight by those who possess the enormous resources of the federal government. So the challenge is to fulfill the financial community’s desire for real-time information while providing information that is sufficiently reliable. It is a formidable challenge to satisfy those competing objectives. Last time, you were cautiously optimistic about the future with respect to financial fraud. How do you feel now? It has, in fact, come about that in the last 18 months or so, fraudulent financial reporting has trended down. We’re not talking about Ponzi-type schemes—but if you look at the conventional corporate types of fraudulent financial reporting involving revenue recognition, etc., it is trending down. The reasons are subject to debate, but the increased focus on internal controls, coupled with the increased awareness about the impact of financial fraud seem to be likely factors. Seeing executives taken away in handcuffs on the news may have had an impact. How do I feel now? In this environment, overly optimistic earnings targets and the kinds of upward pushing pressures that have resulted in fraudulent financial reporting have, to a notable extent, dissipated. Indeed, these days everyone is focusing on the down-side of impairments and going concern references, debt-covenant compliance, and those sorts of things. Don’t get me wrong, those things create their own pressures. And pressure is how fraudulent financial reporting gets its start. Economists tell us that we’re going to be slogging through these tough times for a while. But, at some point, earnings will trend north, and when that happens, analyst pressures will reassert themselves. A recovery may set the stage for a new round of fraudulent financial reporting.

Earnings Guidance: The Current State of Play

11

D. Built To Last: Focusing Corporations on Long-term Performance (CED) In 2007, The Committee for Economic Development issued “Built to Last: Focusing Companies on Long-term Performance.” This report was the result of the work of a subcommittee of the CED that was originally convened to consider corporate performance. As stated in the document, the subcommittee had originally sought to consider this issue from a broader perspective but came to focus upon the causes and outcomes of short-term thinking in corporate decision making. Several key points were highlighted in the paper’s executive summary: Key Points Decision making based primarily on short-term considerations damages the ability of public companies— and, therefore, of the U.S. economy—to sustain superior long-term performance. Emphasis on quarterly earnings, compensation tied to earnings per share, shortened CEO tenures, and financial reports that fail adequately to inform about company performance impede the task of building long-term value. These phenomena are commonly known as “short-termism,” and we believe that it is the responsibility of corporate boards to use their power either to eliminate these practices or to counteract their effect. We call on boards of directors to address these problems by putting the long-term interests of the corporate entity at the forefront of their concerns and demonstrating through their actions that those concerns trump interest in short-term price movements. Specifically, directors can: • Support management’s development of comprehensive strategic plans with appropriate long-term objectives, and continually assess management’s performance vis-à-vis those objectives and interim milestones. • Structure incentive compensation plans so that a significant portion of the income of the CEO and other top executives is tied to the achievement of well articulated long-term performance objectives in line with the corporate strategy. • Insist that corporate reporting be redesigned to include useful non-financial indicators of value, such as those proposed by the Enhanced Business Reporting Consortium, and that such measures count internally for assessment of performance. • Eliminate quarterly guidance on earnings per share. Such guidance encourages a focus on (and sometimes a distortion of) short-term financial results and attracts short-term, speculative trading rather than long-term investing. • Promote succession plans that emphasize growth of internal managerial talent. Doing so would help diminish reliance on costly contracts for recruited executives and may counter the pressure to achieve short-term performance.6

William Donaldson, Chair of the CED’s Corporate Governance Subcommittee, Former SEC Chairman William H. Donaldson was the 27th chairman of the Securities and Exchange Commission. Mr. Donaldson has also served as chairman and CEO of the investment banking firm Donaldson, Lufkin & Jenrette, which he co-founded; chairman and CEO of the New York Stock Exchange; chairman, president, and CEO of Aetna; and chairman and CEO of Donaldson Enterprises, Inc. Mr. Donaldson co-founded the Yale University School of Management, serving as the graduate school's first dean and professor of management studies. His government service spans five presidential administrations and includes serving as undersecretary to then-Secretary of State Henry Kissinger, and counsel and special adviser to Vice President Nelson Rockefeller. Mr. Donaldson is a CED trustee, and chair of CED's Corporate Governance Subcommittee, which authored “Built to Last.”

What are your views on current earnings guidance practices? It might seem that the subject matter of “Built to Last”— best practices in investor communications, and the practice of quarterly earnings guidance—has been overshadowed and is of lesser concern given the scale of the global financial crisis. In my view, just the opposite is the case. I believe the excessive focus by too many corporations on achieving short-term results, fanned by the practice of acceding to demands for regular guidance in forecasting such quarterly results—is certainly one of the root causes of some of the problems we face today.

The demands for short-term performance—and the forecasting of this performance on a quarter-to-quarter basis—have emanated from many quarters. Buy- and sell-side research analysts have succumbed to the pressure of short-term performance goals of individual and professional investors. And technology-based trading systems and programs have increasingly sought short-term trading profits, not long-term investment returns. Through its effects on managerial incentives, quarterly earnings guidance plays a prominent role in generating short-term market pressure and a penchant for short-term thinking among both corporate managers and money managers. This “short-termism” threatens to undermine

“Built to Last: Focusing Corporations on Long-term Performance,” The Committee for Economic Development, 2007

6

12

our economic future. Equally as important, short-termism weakens the ties that bind business and society. How do these practices impact corporate decision making? The not-so-distant failures of Enron and WorldCom ought to be sufficient reminders of how pressures to meet financial markets’ quarterly earnings expectations can narrow and distort the focus of corporate leaders. Executives turn away from the goal of creating an enduring enterprise based on a long-term value proposition and the efficient execution of strategy, and towards the tactical objective of “hitting the numbers”—even if that means bending the rules and risking the demise of the corporation. And we should not forget that financial failures like those of Enron and WorldCom have real-world consequences: shareholders of those companies were wiped out; other shareholders suffered collateral damage; workers lost jobs, health insurance, and the promise of a secure retirement; entire communities were decimated. At a systemic level, the American people lost trust and confidence in business and business leaders. Passage of the Sarbanes-Oxley Act and other steps taken by regulators, market exchanges, and individual businesses were necessary to restore that trust and confidence in U.S. corporations. Although today’s economic worries seem quite different from the particular malfeasances associated with corporate failures earlier this decade, the underpinning problem of short-termism remains with us. Practices like quarterly earnings guidance, which feed short-termism, continue to impose costs on shareholders and other stakeholders who compose the overall economy. Though the costs of short-termism are less visible now, they can still be seen in the unnecessary and inefficient deferral of investments and liquidation of assets that take place as managers try to make their quarterly numbers, the shortened average tenure of CEOs, and reduced investor returns over the long haul, to name a few. We also know from surveys that another important cost is the lost time of corporate directors and managers who would rather engage in higher-valued activities such as analyzing and discussing their firms’ long-run strategy rather than worrying about how to avoid missing this quarter’s mark or how to explain to analysts why they won’t miss the mark next quarter. Are there larger, societal costs to the focus on shortterm performance? Short-termism imposes a less visible cost, by weakening the ties between the corporation and society. Any society, but especially the United States at the beginning of the 21st century, depends on its business enterprises, in particular its publicly traded corporations, to achieve economic goals of job, income, and wealth creation. Increasingly, public corporations face demands from shareholders and other stakeholders to take into account how their performance interacts with and is affected by such societal concerns as climate change, environmental damage, human rights,

and globalization, to name some of the most prominent. In response, leading corporations are developing business strategies that soberly confront these societal challenges as a means to ensure their own long-term prosperity and sustainability, as well as the sustainability of the society of which they are a part. By contrast, financial markets’ focus on quarterly results hinders this search for new solutions and diminishes the corporation’s ability to consider and act on long-term societal issues. The point is this: business and society depend on each other. Our society relies primarily on corporate businesses to innovate, invest, and employ resources to generate income and wealth. Short-termism—exemplified by the practice of quarterly earnings guidance—exacerbates tensions between public goals and private decision making, which ultimately can imperil our long-term standard of living. Why do so many companies still follow this practice? I don’t mean to suggest that all short-term actions or decisions are evil, or that all corporations that choose to provide quarterly earnings guidance should be condemned. Of course, some short-term orientation, quarterly profit making, and attention to financial indicators is natural, unavoidable, and sometimes even desirable. Corporate directors and managers typically confront high levels of risk and uncertainty both inside and outside of the corporation, which necessarily foster some short-term thinking. But survey after survey of corporate executives confirms what academic research suggests: obsession over short-term results by investors, asset management firms, and corporate managers—of which quarterly earnings guidance is but one manifestation—sacrifices long-term value, decreases market efficiencies, and reduces overall investment returns. Of course, many directors and managers remain reluctant to change. The current system rewards them for not changing. When surveyed, most CEOs say they had no plans to shift away from earnings guidance. Most fear that share prices would drop or become more volatile. And there is some research that supports that view. But, of course, such findings only tell us what we already know: the current system rewards those who manage within its conventions, and it is those conventions and practices that need changing. Other research findings on quarterly earnings guidance tell us that earnings guidance acts like a magnet to hedge funds and other active traders, and can increase, rather than decrease, share price volatility. What is the role of the board of directors? Ending the quarterly earnings guidance game, though a giant step in the right direction, will not by itself solve all of the problems of short-termism. That will take a broader change of thinking and, in my view, one that must be promoted by corporate directors. Directors need to assert their critical role as stewards of the corporation and insist that it be managed in a manner mindful of the long-term sustainability of the firm. Analysts and investors too should be looking to evaluate companies based not on their ability to fulfill quarterly predictions of earnings per share but on their long-term sustainability.

Earnings Guidance: The Current State of Play

13

The Case at Hand: Company Perspectives Authors' Note: An interesting, albeit understandable, change since our first report was the hesitancy of executives to participate. We approached a broad range of executives in a variety of industries. A few were willing to be “on the record,” but many were not. The authors are especially grateful to these executives who were willing to provide their thoughts. In addition, we have reprinted the interview with the late James Cantalupo, then-CEO of McDonald's Corporation, as Appendix A to this report. Mr. Cantalupo was particularly candid in expressing his views in 2003. Current Perspectives from the C-Suite: David Lyle is the chief financial officer of Entropic Communications, Inc. (Nasdaq: ENTR). Entropic Communications is a pioneer in connected home entertainment technologies. Lyle says, “We are a product cycle story, dependent on television service providers, with a new generation of services. Our products allow telecommunications carriers, cable multiple service operators and digital broadcast satellite service providers, to enhance and expand their service offerings and reduce deployment costs in an increasingly competitive environment. We did our IPO in late 2007, and it was one of the last IPOs before the downturn.” Currently, there are nine analysts that cover the company. This is down from 12 reflecting a general downsizing within the analyst community. The company provides quarterly earnings guidance as well as qualitative information on long-term strategy based on Entropic’s 3- to 5-year long-range strategic plan, which is updated annually. When asked what benefits the company derives from their current guidance practices, Lyle noted that earnings guidance is fairly standard in the semiconductor industry, and if it wasn’t provided it could decrease investment and increase volatility. “We think that we would lose investors if we stopped providing earnings guidance. However, we did change how we provide guidance in the first quarter of this year because of economic uncertainties. We changed our practice by broadening the range of earnings guidance that we provide.” This is consistent with the trend identified in the NIRI study referenced in the first section of the report. The number of companies providing guidance as a range greater than 5% increased from 38 to 42 percent in 2009 over 2008.

These comments likely reflect the feelings of many smalland mid-cap company executives who contend that they are not recognizable enough for analysts to take the time and effort required to generate their own estimates. To be covered at all, these companies would argue, they must provide specific financial performance measures. Most often, as confirmed by the NIRI survey, these financial performance measures take the form of quarterly earnings targets. A C-level executive of an Internet-based retail company shared a similar story. This company has about 18 analysts covering it. “We provide quarterly earnings guidance because we are more likely to be more accurate than the analysts given the significantly greater visibility we have into our own business at any given time. They cover too many companies and can’t spend the time to develop a detailed estimate for our company. The obvious downside when they get it wrong is increased volatility.” The company has, however, changed the way it provides guidance. Previously, the company provided annual and quarterly targets at the beginning of the year. Now, the company provides guidance on a quarter-to-quarter basis: guidance for the next quarter is provided as part of the company’s quarterly.earnings press release. In addition to EPS targets, estimates are provided for key sales metrics, as well as EBITDA and key expense data. Matt Orsagh, senior policy analyst for the CFA Institute, responds to the concerns companies often express about the analyst community’s ability to create meaningful models without quarterly earnings guidance. “I have never found this argument to be particularly compelling. When a company provides enough information about its strategy and the drivers of business performance, a good analyst is able to create an appropriate model. Those analysts that can’t provide meaningful, predictive analysis will be punished by the marketplace in the long run and those that can will be rewarded. If analysts aren’t spoon-fed results, the cream should rise to the top.” Orsagh concedes that some analysts—particularly sell-side analysts—rely in some way on earnings guidance. In a May 2008 survey of CFA Institute members,7 46% of sell-side and 32% of buy-side analysts said that they “always use” quarterly guidance in developing company analysis. However, a strong 70% of those surveyed believed it

“Short-termism Survey: Practices and Preferences of Investment Professionals”, CFA Institute, May 2008

7

14

would be better practice not to provide quarterly earnings guidance. Those that eschewed quarterly earnings guidance overwhelmingly cited the need of the company to focus on the long-term as their reason. One could conclude, then, that while the analyst community would rather a company shift away from quarterly guidance, when it is provided they feel compelled to use it. The key, he contends, is providing information that the analysts actually find useful. The overwhelming majority of analysts surveyed, for example, wanted companies to provide longer-term (e.g., annual or even longer) guidance for more metrics, such as revenue, capital expenditures, cash flow, and gross margins. A similar majority wanted more nonfinancial guidance around industry developments, trends, market conditions, and other nonfinancial drivers of performance. Tellingly, only about 53% of these investment professionals estimated that more than half of the companies they cover adequately communicate on strategic priorities – meaning that about 47%, or almost half of investment professionals surveyed, believe that more than half of the companies they cover do not adequately communicate their strategic priorities. Many executives may be concerned about eliminating forward-looking earnings guidance because of negative perceptions by the market generally regarding the underlying reasons for the change. These market perceptions seem to be rooted in prior experience. A 2007 academic study, “To Guide or Not to Guide: Causes and Consequences of Stopping Quarterly Earnings Guidance,” examined over 200 companies that stopped providing such guidance over approximately a two-year period. “In a nutshell, guidance cessation follows a poor operating performance and causes a deterioration in the information environment about the company. The major benefits claimed from stopping quarterly guidance - enhanced investment in the long-term and increased strategic disclosures - do not appear to materialize. Moreover, 31% of the stoppers in our sample subsequently resumed quarterly guidance, suggesting that it is rather difficult for firms to buck the trend and abstain from quarterly earnings guidance. Thus, we conclude that, consistent with economic theory, decreasing disclosure stopping guidance in our case - does not seem to benefit investors or firms.”8 When asked about the drawbacks of providing guidance, Lyle said that providing earnings guidance can be a “double-edged sword. If you miss your numbers, guidance can impair your credibility and your stock could take a hit.”

8 "

Our second interviewee acknowledged that the nature of any business is such that there is always pressure to perform financially, but said he doesn’t recall a time when the company made a business or investment decision based solely on the impact on previously provided earnings guidance. But one must wonder about the impact of the recessionary global economy on fraud risk. Because publicly-issued earnings guidance is both highly-visible and linked to executive wealth, it may be a primary source of pressure—one of three primary factors contributing to financial fraud. Consider the following from a 2009 Deloitte whitepaper, “Financial Fraud: Does an Economic Downturn Mean an Uptick?”: “Management is often under pressure to meet short-term performance goals, such as earning expectations, revenue forecasts, or financial rations tied to debt covenants. In addition, management is often compensated with stock options or other equity instruments intended to align management and shareholder interest. With management’s own performance and compensation tied to operating or financial goals, management may drive its employees to achieve overly optimistic results—particularly in an economic slowdown.” When combined with additional opportunities (resulting from downsizing and expanding workloads) and rationalizations (resulting from a general distrust of corporate leaders), the whitepaper concludes that the risk of fraud may very well be higher in a downturn. As previously noted and supported by the NIRI survey, there are many companies that have chosen not to provide quarterly or annual earnings targets. Progressive Insurance, which was noted in our first report for its policy not to provide forward-looking information, has the following disclosure on its investor relations web site: Analyst Earnings Models and Reports "Progressive does not share earnings projections and does not provide focused guidance to analysts in their efforts to develop earnings estimates. We may make forwardlooking statements using the safe harbor as prescribed in SEC rules and the Private Securities Litigation Reform Act of 1995 to enable the investment community to better evaluate the Company and its prospects for performance. We do not review analysts' reports and do not comment on their conclusions, earnings estimates, or investment recommendations. Progressive regards analyst reports as proprietary information belonging to the analyst's firm."

To Guide Or Not to Guide? Causes and Consequences of Stopping Quarterly Earnings Guidance", Joel F. Houston, University of Florida -

Department of Finance, Insurance and Real Estate; Baruch Lev , New York University - Stern School of Business; and Jenny Tucker, University of Florida - Warrington College of Business Administration; 2007

Earnings Guidance: The Current State of Play

15

This policy is shared by MasterCard Inc. (NYSE: MA). According to Barbara Gasper, senior VP of investor relations, MasterCard made the decision to not provide earnings guidance before they went public in May 2006, and the investment bankers who took the company public supported this decision. The thought was to keep the focus on long-term performance and avoid a focus on short-term performance. Instead of quarterly or annual guidance, the company provides three-year performance objectives related to net revenue, operating margin, and net income growth. In addition, management should be prepared to discuss some types of metrics, but they do not have to be earnings per share. For example, MasterCard has provided some sensitivity analysis to help investors better understand the potential impact of things such as foreign exchange. “We have said that for every one cent move in the exchange rate between the U.S. dollar and the euro, our net revenue and operating expenses are impacted by X and Y annually, based on our current mix of business. This way, investors and analysts can make whatever assumptions they want to around currency movements and integrate those into their own models.” Gasper noted that originally MasterCard was pressured by some sell-side analysts (the company is covered by 23 analysts) to provide earnings guidance, but the analysts have now accepted that MasterCard does not plan on providing it. On the other hand, some of the buy-side analysts actually prefer that MasterCard does not provide earnings guidance. Berkshire Hathaway Inc. (NYSE: BRK) communicates its policy on earnings quality and guidance in the straight-talk manner that is its trademark. Chairman and CEO Warren Buffett created “An Owner’s Manual to Berkshire’s Class A and Class B Shareholders,” which is available on the company’s website. The following are excerpts from the 13 principles included in the manual: “At Berkshire you will find no “big bath” accounting maneuvers or restructurings nor any “smoothing” of quarterly or annual results. We will always tell you how many strokes we have taken on each hole and never play around with the scorecard. When the numbers are a very rough “guesstimate,” as they necessarily must be in insurance reserving, we will try to be both consistent and conservative in our approach.” “In all of our communications, we try to make sure that no single shareholder gets an edge: We do not follow the usual practice of giving earnings “guidance” or other information of value to analysts or large shareholders. Our goal is to have all of our owners updated at the same time.”9

9 10

16

"Owner’s Manual"; Berkshire Hathaway, Inc., 2006 Intel Corporation, Investor Relations web site; www.intel.com.

Berkshire Hathaway, of course, is legendary for its annual letter to shareholders. This, some would argue, is the gold standard against which other investor communications methods are measured. In the letter, Buffett provides an analysis of the company’s historical performance, as well as the story of the company’s prospects for the future. One has to wonder if the investor community would give the same weight to this story if Berkshire Hathaway also provided quarterly earnings guidance. Would the “target” distract from the broader story of the company’s strategy and vision? While some companies have made it a general corporate policy not to provide specific forward-looking earning targets, others may have scaled back due to the general economic uncertainty. With the future so unclear, executives have considered the risks associated with providing such information to be greater than the potential benefits. Consider this announcement on the business outlook section of Intel Corporation’s investor relations web site: Current uncertainty in global economic conditions makes it particularly difficult to predict product demand and other related matters and makes it more likely that Intel's actual results could differ materially from expectations. Consequently, the company is providing less quantitative guidance than in previous quarters.10 Again, the NIRI study confirms this as a trend as opposed to an isolated incident. One of the reasons respondents most frequently cited for reducing or eliminating earnings guidance related to an inherent inability to make reasonable predictions in the current economic environment. Our Internet executive indicated that the company eliminated annual guidance in favor of a quarter-by-quarter target as “analysts would so heavily discount the predictive value [of annual EPS targets] that the measure becomes virtually useless.” It isn’t clear to the authors whether this trend will reverse itself as the economy recovers. Industry practice—as referenced by Mr. Lyle in his remarks—is sure to influence an individual company’s earnings guidance policies. A 2006 study of Fortune 500 companies administered by Thomson Financial indicated that a majority of all companies in this index provided EPS Guidance (84.11%). A look at the industry data pointed out that there were notable differences among industries. For example, the energy companies in the study were least likely to provide EPS guidance—only 50% were doing so at the time of the study. Interestingly, the utilities industry was at the exact opposite of the spectrum, with 100% of the examined companies providing guidance.

The findings for each industry are presented below.11 Industry

Number of Companies in Sample

Percentage Providing EPS Guidance

Consumer Discretionary

81

83%

Consumer Staples

37

92%

Energy

28

50%

Financials

76

87%

Healthcare

55

96%

Industrials

52

92%

Information Technology

76

80%

Materials

31

68%

Telecommunications

7

57%

Utilities

29

100%

Total in Study

472

84%

Of course, this study was performed in 2006—before the current credit crisis and resulting economic turmoil. However, it certainly provides a useful benchmark in terms of where industry practices may eventually return to upon economic recovery—all other things being equal. For its part, NIRI has a number of policies for investor communications professionals. The most significant underpinning is that there is no single standard for earnings guidance that can be applied to all companies. In fact, NIRI’s policy points out that even if a company doesn’t provide specific quarterly EPS targets, it is not immune to the pressures of the short-term: “NIRI recognizes that the decision of public companies to provide or not provide quarterly earnings per share guidance alone will not reduce the increasingly shortterm focus of the marketplace, which may be as short as intra-day in some cases. Furthermore, the influence of additional factors such as quarterly reporting requirements, quarterly compensation targets of many investment managers, publishing of quarterly earnings estimates by financial analysts and media focus on public companies ‘beating’ or ‘missing’ these quarterly estimates continue to place undue emphasis on quarterly results. NIRI supports a focus on long-term business value drivers by all financial markets participants—public companies, financial analysts, investors and the media—a focus that will ultimately lead to reduced volatility and a lower cost of capital.”12

Making a change: Points to consider: Certainly, striking the right balance of information to provide investors is neither simple nor a one-time decision. Companies need to consider the type and amount of guidance in areas such as quantitative vs. qualitative; financial vs. nonfinancial; as well as specific targets vs. a range of values. In fact, the CFA Institute/Business Roundtable study suggests that a “lifecycle” or “maturity model” concept may be the best approach. For fairly new, small-cap companies, there may be few options other than to provide specific earnings targets to the market. But as a company matures, a shift away from earnings targets may be appropriate. "In recognition of the difficulty some companies may encounter in a abruptly ending quarterly earnings guidance, the panel [that created the report] introduced the concept of an ‘earnings guidance lifecycle’ as a method to replace the current ‘one-size-fits-all’ quarterly guidance model and allow companies to improve the quality of their disclosures on the basis of company-specific and industry characteristics. The lifecycle concept also supports a process for companies to ultimately end focused earnings guidance ... In today’s capital markets [certain companies] may not have the strategic option of providing less than quarterly guidance. As the company grows and/or diversifies its products, services, and markets, however, it can tolerate potential fluctuations in volatility and investor sentiment that may occur with less frequent earnings guidance. Still later in the corporate lifecycle, the company may have matured to the point of focusing on managing the business for the long term and have little need to provide earnings guidance to outside sources.”13

“Trends in Earnings Guidance”; Thomson Financial; April 2006 “NIRI Policy Statement: Forward-Looking Guidance Practices”; National Investor Relations Institute Executive Alert, August 20, 2008 13 “Breaking the Short-Term Cycle”; CFA Centre for Financial Market Integrity/Business Roundtable Institute for Corporate Ethics; copyright 2006; pgs. 7-8 11 12

Earnings Guidance: The Current State of Play

17

The elimination of—or significant reduction in—precise earnings guidance necessitates a fresh look at the other, more qualitative information to be provided to investors. When one global financial services company recently decided to do just that, it asked Deloitte to conduct research about leading practices for both historical disclosures and forward-looking earnings guidance. The overall results of the research were consistent with those of the Thomson Financial study, shown above, for the financial services industry; however, a deeper examination of the corporate practices revealed three additional angles a company might choose to highlight when telling its story. The following is excerpted from an article related to the study:

• Management Confidence and Trust. Some companies have such a strong track record of meeting or exceeding investor expectations that the market is willing to accept their story more or less on faith. Many of the world's most respected companies fall into this category. For example, one highly profitable investment banking firm provides investors and analysts with very little guidance or insight into its business, preferring to let the firm's performance speak for itself. Establishing this level of confidence and trust isn't easy; however, companies that have achieved it should definitely use it to their advantage. A similar technique is to showcase a team of senior executives responsible for a region or market segment that is particularly critical to the company's profitability.14

• Strategic Initiatives. A number of [the companies in the study] tell their story by focusing on their overall strategy and the key initiatives that support it, which helps them gain the market's confidence. If investors and analysts find the story and strategy compelling, management can provide guidance simply by showing that the strategic initiatives are on track. A number of leading financial institutions use this as their primary approach to guidance. One insurer even goes so far as to produce a separate supplemental disclosure that describes the progress the company is making against its strategic initiatives.

The company that commissioned the study made several meaningful changes to the amount, quantitative vs. qualitative balance, and timing of its guidance to investors as a result.

• "Big Picture" Trends. Other companies tell their story by linking the company's prospects to larger trends such as macro-economic factors and demographic shifts. If analysts and investors buy into the company's overall strategy—and how it relates to the larger trends—they are likely to remain on board as long as the trends continue to unfold as expected. A leading Internet company relies on this technique as its primary approach to providing guidance. As long as Internet usage continues to expand in size and scope, investors and analysts are likely to maintain their rosy view of the company's market value and future prospects. Other companies use a similar approach, but hitch their fortunes to trends such as interest rates, energy prices, and immigration patterns.

14

18

When asked what advice she would give financial executives who are currently considering the guidance issue, Barbara Gasper of MasterCard said, “I think that financial executives should seriously consider keeping analysts focused on long-term performance.” She provided several factors to consider: 1. Financial executives should try to understand how well they can forecast performance internally. Do they have a robust forecasting process? If they cannot do a good job forecasting performance internally, consider whether they should provide any type of earnings guidance. 2. Financial executives should also determine senior management’s appetite for share price volatility; this volatility can result when the company does not provide earnings guidance. Keep in mind that analysts will develop their own earnings estimates whether or not you provide guidance; however, there may be less share price dispersion around the average earnings consensus. 3. Companies should take into consideration their own industry’s practices regarding earnings estimates. If they decide not to provide earnings guidance, they need to provide information on other important metrics used by their industry. The Street needs to have something to use to estimate future performance. 4. Companies need to clearly articulate the reasons for a change so that the decision is not perceived to be a knee-jerk reaction to a short-term problem. They need to substitute other performance measures, so that the Street can recalibrate its estimates.

“Earnings Guidance: The Real Issue”; Silvers and Huang; .Directors & Boards, Second Quarter 2008

A 2008 policy brief issued by the Millstein Center for Corporate Governance and Performance,15 “Talking Governance,” concluded that companies are thinking about shareholder dialogue in new ways. While the policy paper was focused primarily on board/shareholder communication and more specifically around executive compensation, one key takeaway was that companies are being more proactive in their efforts to sustain a dialogue with investors on a broader range of issues. A great example that appears to have gained traction in the marketplace was started by Pfizer, which invited a number of its large institutional investors to share their views with management and the board in a “listening session.” Anecdotal evidence from the report also indicated that similar listening tours have been implemented by other companies and have been expanded to include issues related to strategic vision and long-term value. Such sessions can also provide a venue for companies to hear investor views on the kind of quantitative and qualitative information they would like instead of—or as a supplement to—earnings guidance.

In an article for InvestorRelationships.com, Editor Broc Romanek offered a number of considerations for companies considering a change to their previous guidance practices. The full article is included in Appendix B; however, a few highlights are provided here. • Board Actions: The board and audit committee have an important role to play. The audit committee should be consulted whenever a financial communication policy change is contemplated. When a company is widely followed or if a change is likely to be met with resistance from the investor community, it may also be prudent to discuss a change with the full board. Management should provide sufficient detail around the previous policy, the change sought, and the potential impacts. • Announcement of Change: Any communications regarding a change in guidance should be made with the requirements of Regulation FD in mind. Companies must also be mindful of 8-K filing requirements and stock exchange listing standards. In announcing the guidance change, management should provide the reason for the change and, if applicable, consider including the reason in the earnings release in order to inform the market and preempt questions from the analysts. Several examples are provided in Appendix B. • Earnings Call Preparation: If the announcement is being made on an earnings call or other public conference, review the CEO/CFO’s script and any slides and monitor the presentation to ensure compliance with Regulation FD. Also be sure to review talking points for any management follow-up analyst calls after the earnings call, if the company allows such follow-up calls.

The appendices of this report provide a wealth of information about guidance, guidance practices, and principles to consider in establishing new guidance policies. These documents can be used to frame a company’s planning processes with respect to forwardlooking information. They offer senior financial executives the information necessary to make the difficult decisions about future guidance practices of their organizations and the tools to put those plans in place.

“Policy Briefing No. 2: Talking Governance: Board-Shareowner Communications on Executive Compensation”, Alogna and Davis, Milstein Center for Corporate Governance and Performance, 2008

15 

Earnings Guidance: The Current State of Play

19

A Related Thought In writing this report, the authors considered a separate but related issue. Most companies release earnings prior to filing their annual and quarterly reports. Typically, this means that the audit or quarterly review process is still ongoing at the time of the earnings release. During the window between the earnings release and the filing of the SEC reports, there is a risk that the results will change. The longer the window is, the greater the risk of a change. Conversely, companies can reduce this risk either by aligning the earnings release with the filing of the related SEC reports, or, at a minimum, reducing the period of time between these two events. The timing of a company’s earnings release may have been previously driven by industry practice, and of course there is a natural inclination to keep the status quo when dealing with investors, either for competitive reasons or out of fear that change will signal something negative to the street. However; more and more financial executives are interested in implementing policy changes that encourage high-quality, accurate financial reports. Eliminating the inherent pressures of an exceptional lag between earnings release and filings is just one of the ways to do so. In general, we believe this is a positive trend. When handled thoughtfully and communicated with sufficient notice, a change of this nature is likely to be taken in stride by the investor community. In the context of reviewing overall investor communications with respect to earnings guidance, we suggest that companies should consider this point as well.

20

Conclusion: And a Call to Action It is difficult to reach a clear, universal conclusion regarding the appropriateness of forward-looking earnings guidance. While various organizations continue to push for changes in the practice, the majority of companies seem largely unconvinced. Companies are hesitant to change, in part, because they fear how investors will react. At a minimum, the authors recommend that companies take a fresh look at their policies in light of the recent reports on the topic cited throughout this report. Importantly, this process should occur at the highest levels of the organization. Led by the CEO and CFO, with significant input from the board, the discussion should include an outreach to important constituencies and a review of current industry trends. Completing this review may enlighten the process of developing this information or it may call into question the nature, extent, and timing of information provided to investors. The decision of whether to provide guidance—including the nature, periodicity, and frequency of such guidance—should be subject to periodic review. If a company decides to continue providing earnings guidance, it is important for boards and executives to consider how their current practices may influence management decision making. We believe that, when combined with other efforts to restore investor trust, a fresh approach to these issues can have a lasting impact and can benefit companies and investors alike.

Earnings Guidance: The Current State of Play

21

Appendices A.

In Memoriam: An Interview with Mr. James Cantalupo

B. Facing an Unpredictable World: How to Change Earnings Guidance Practices by Broc Romanek C. Apples to Apples: A Template for Reporting Quarterly Earnings, by the CFA Center for Financial Market Integrity D. Long-Term Value Creation: Guiding Principles for Corporations and Investors, The Aspen Institute’s Business and Society Program

22

A. In Memoriam: An Interview with Mr. James Cantalupo This interview is a reprint of the James Cantalupo interview which appeared in the first “Meeting the Street”. Mr. Cantalupo died in April 2004. At the time of this interview, he was the Chairman and Chief Executive Officer, McDonald’s Corporation. A 28-year veteran of the company, Mr. Cantalupo served as president and vice-chairman of McDonald’s Corporation and CEO of McDonald’s International. He served on the boards of directors of Sears, Roebuck, and Co., Illinois Tool Works, World Business Chicago and the Chicago Council on Foreign Relations. He was an honorary member of the board of trustees of the Chicago chapter of the National Multiple Sclerosis Society and a past president of the International Federation of the Multiple Sclerosis Societies. Mr. Cantalupo served on the board of trustees of Ronald McDonald House Charities, and as a director of the Northern Trust Bank/DuPage.  an you tell us about the events and circumstances that C caused McDonald’s to decide to stop providing earnings guidance? Historically, our business lent itself to providing forwardlooking earnings targets. We were very formalized and fairly simple, at least on the surface. Analysts loved to cover us because they were rarely wrong. Over time, we began to globalize our business. Today, nearly half our earnings are generated outside of the United States. We operate in 120 countries worldwide, and the socioeconomic environment of each one, to varying degrees, influences our financial results. This has changed the “crystalball” landscape considerably. Our ability to predict quarterly earnings with the precision the investment community was looking for was severely impacted. We were also at the beginning of a revitalization plan for the business, and we wanted to emphasize our targets for the next 18 months to three years, not the next few quarters, both internally and externally. In that situation, there was no point in putting ourselves on the line with quarterly earnings targets. T he decision has changed our focus from the short term to the long term pretty dramatically. We had always looked at things from a quarter-to-quarter perspective. Of course, that can never go completely away as long as there are analysts out there making projections.

The decision [not to provide earnings estimates] has changed our focus from the short term to the long term pretty dramatically. We had always looked at things from a quarter-toquarter perspective. James Cantalupo front of us that required a total refocus. The analysts didn’t think it was unusual and were actually quite supportive of the position. We really didn’t have a lot of push-back, and I was very pleased with how the market reacted. I think the positive reaction was partly related to the fact that we did provide some guidance to analysts on specific drivers of earnings—we simply didn’t give them specific EPS targets. The information we provided for 2003-04 can be easily worked into the analysts’ models. We repeated the same process in April with updated information on forecasted capital expenditures. Also, we’re now releasing actual monthly sales information. If there’s something important that investors need to know, we’ll mention it. In our business, same-store sales are really critical, so we give that in all our releases. We’ll reassess this decision in the future. When we get back on track and our business model is more developed, there’s really no reason why we couldn’t have the same predictability we had before. Then we might be in a position to provide even more projected information. For now, we have provided a picture of targeted, sustainable top-line and operating income growth that can be expected beginning in 2005. We recognize the next couple of years will be rebuilding years.  ow did the board of directors react to the decision? H Our board was positive because the company had missed several prior projections. It was not a decision made by the board; it was made by management. The board also agreed that monthly sales releases made sense.

I happened to be on four other boards at that time, all of which were providing earnings estimates. I feel the same way How did the market react when McDonald’s announced regardless of which role I’m in. Providing precise quarterly it would no longer provide earnings estimates? Also, earnings projections just doesn’t seem to have a lot of what types of information are you providing? upside potential. Companies have plans, and events unfold We announced in January just after I came back from much differently, so providing an annual plan up front and retirement. The market knew the situation, and we continuously providing actual results seems to be a more approached it from the standpoint that we had a big job in sensible model to follow. Earnings Guidance: The Current State of Play

23

B. Facing an Unpredictable World: How to Change Earnings Guidance Practices By Broc Romanek, Editor of InvestorRelationships.com16 During the past six months, a number of companies have revisited their earnings announcement practices and have decided to suspend or terminate providing guidance or reduced the frequency of their guidance (e.g., from quarterly to annual). This trend has accelerated with deteriorating economic conditions. Recently, some companies have foregone giving guidance because current economic conditions are so difficult to decipher; while others may have used the financial crisis as an excuse to duck a practice that they have been considering cutting for some time. The most recent benchmarking on these practices is a 2008 National Investor Relations Institute survey, which showed that 36% of respondents do not provide financial guidance. Since then, General Electric, Intel, Advanced Micro Devices and Texas Instruments have announced termination, suspension or reduction in their practice of providing guidance. The changes include no longer providing quarterly guidance; no longer providing EPS guidance; no longer providing formal guidance (and instead providing “internal guidance”); and providing a larger range when guidance is provided. Steps to Consider in Changing Guidance Practices 1. Board Actions In many cases, a company will have been considering whether - and how to stop – changing their guidance practices for some time before it does so. It is not uncommon for a company’s disclosure committee (and/or the IR department or outside IR advisors) to be the first to raise the question after the company "misses" hitting the mark one or more times. - Audit Committee’s Role - Many companies "preview" earnings calls with the audit committee chair. Even for those that don’t, it typically is the audit committee - or at least the committee chair - that first discusses a change in guidance practice at the board level. For many companies, the audit committee likely will have the “final say” and will report the decision to change practices to the full board. - Full Board’s Role - If a company is widely followed or changing guidance would be met with particular resistance from the investment community, it would seem prudent to allow the entire board to consider it upon recommendation from management and the audit committee. This also might be the case for smaller companies where attracting an analyst following is important. 16

24

Even if full board approval isn’t sought, management (along with the audit committee chair) should discuss the concept of changing guidance with the board at some point during the time of internal deliberation, explaining the reasons why it may be advisable as well as the possible risks. - Board Materials – For board materials, it may depend on the level and type of materials the audit committee and board typically receive before guidance is issued. It may include an explanation of the reasons for management’s recommendation to change guidance, including the pros and cons; an analysis of the potential investor relations’ impact; examples of other companies who recently have changed guidance in the same way; and a comparison of what peer companies are doing in the same industry. - Whether Formal Board Approval is Required - When the decision to change guidance practices is made, the board probably doesn’t need to approve the decision formally in a resolution or otherwise, since they didn't approve giving guidance in the first place (however, if the original decision was the product of a formal board approval, the board should approve an amendment). It should be sufficient if the minutes reflect a discussion with the board. 2. Announcement of Change - Reg FD-Compliant Announcement - Announce the change in guidance practice in a Reg FD-compliant manner. For example, if a company is going to announce the change on an earnings call, it should issue a press release well in advance of the call providing details on how the public can access the call. For consistency sake, we recommend making the announcement in the same manner, e.g., Form 8-K or press release, in which the guidance was originally given. - Form 8-K Considerations - If the announcement is not part of an earnings call and takes place shortly after the end of a quarter, caution against delving into specifics about the just-ended quarter’s results to avoid an Item 2.02 Form 8-K filing requirement. - Press Release Considerations - If the company is listed on NYSE, it is required to make announcements of material information through a press release. Consider whether deciding not to provide guidance for a particular period is necessarily material by itself. - Clearly Explain the Rationale for the Change - In announcing the guidance change, provide the reason for the change and, if applicable, consider including the reason in the earnings release in order to inform the market and preempt questions from the analysts. If the reason relates to the uncertain economic conditions, a starting point for this disclosure could be: “Due to the economic uncertainty

Reprinted with permission from the Spring '09 issue of InvestorRelationships.com.

and unpredictability [of retail markets, foreign exchange rates etc.] forecasting our full year results would be difficult at this time. Therefore, we have made a decision to discontinue annual guidance until conditions normalize and long term visibility improves.” One point to bear in mind: analysts may well call to find out more information after this type of reason is included in an earnings release. In deciding how to explain the guidance change, consider the disclosures provided by other companies that have changed their guidance: a. “[General Electric] also announced that it will no longer provide specific quarterly EPS guidance. Instead, the Company will provide a full-year operating framework with detail in the industrial and financial businesses. The Company remains committed to high levels of disclosure and transparency, and will continue to report all of its quarterly segment details.” b. “Due to economic uncertainty and limited visibility, Intel is not providing a revenue outlook at this time.” c. “In light of current macroeconomic conditions, very limited visibility and continued corrections in the supply chain, AMD expects first quarter 2009 revenue to decrease from the fourth quarter 2008.” 3. Preparation for Earnings Calls - Remind Executives of New Policy - Educate executives on the new guidance policy and prepare them to handle questions from analysts and others who may still push for guidance. Management must remain disciplined and resist the temptation to give guidance, only referring to the previously publicly disclosed information. - Review Talking Points in Advance - If the announcement is being made on an earnings call or other public conference, review the CEO/CFO’s script and any slides and monitor the presentation to ensure compliance with Regulation FD. Also be sure to review talking points for any management follow-up analyst calls after the earnings call, if the company allows such follow-up calls. Practice Pointers Here are some practice pointers that Davis Polk & Wardwell recently provided: • Guidance and Subsequent Events - Macroeconomic uncertainty increases the risk that prior financial guidance, however well considered when given, will be overtaken by events. The 1995 Private Securities Litigation Reform Act created a safe harbor for “forward-looking statements,” and most companies that provide financial guidance have good practices for identifying statements as forward-looking, referring to appropriate risk disclosures, disclaiming a “duty to update,” and not later reaffirming the guidance. The incidence and success rate of private litigation with respect to “missed quarters” are sharply down. Even so, companies face a difficult decision if it becomes clear that previous guidance is now materially off target. The decision to revise guidance or to preannounce results

is in our experience more often driven by reputational concerns and relationships with investors and analysts than by purely “legal” concerns. Remember, though, that litigation on these subjects continues to occur, and the plaintiffs’ bar can be creative in challenging whether guidance was given in good faith or whether subsequent actions amount to reaffirmation of the guidance. Less guidance will generally mean a smaller target for plaintiffs. • Regulation FD Risk Profile - Formal guidance in a press release or public conference call provides a definitive “statement of record” to which spokespersons may refer in subsequent conversations. In the absence of guidance you should expect an increased level of dialogue with investors and analysts who will be looking for facts or suggestions, or body language, from which to infer management’s expectations. • This puts a premium on training and discipline for all spokespersons up to and including the CEO. Spokespersons should be fully briefed as to what they can and should not say, and should understand that in the case of a mistake they need to alert the Legal department promptly to enable the company to take advantage of Item 7.01 of Form 8-K. • Risks and Benefits of Expanding Consensus Range Companies that stop giving guidance should expect that sell-side analysts, left to their own devices, will be less tightly bunched than before. Many companies view this as a positive feature, as it in effect gives you a larger target to hit. But it also increases the risk of a true outlier: the analyst who is either proceeding from a different worldview (which is fine) or who has gotten his or her sums wrong. In the latter case there will be a strong temptation to “correct” the analyst’s mistake, which again raises the specter of a Regulation FD problem. • Choosing When to Stop - The best time to limit or to stop giving guidance, of course, is when you have just hit your number. Suspending guidance after your third consecutive miss, by contrast, smells more of despair than of a change in philosophy, and may reflect negatively on management. It may still, however, be the right thing to do. • Nature of Industry - If the company is in an industry that has clear competitors - and all those competitors give guidance – it would be more difficult for the company to change guidance practices. The company would not want to suggest that they have less foresight into their business than their competitors. It’s also tougher to make the general macro arguments if no one else in the industry is following suite. • Coverage Implications - A company’s willingness to provide guidance may at the margin affect a sell-side analyst’s decision to begin or continue coverage. For highly visible, large-cap companies this will generally not be a factor, but it could be an important consideration for smaller companies seeking to hang on to or expand coverage. Earnings Guidance: The Current State of Play

25

[Note from Broc: I think this is a big consideration for small companies. They typically have a big fear of losing analyst coverage so they may feel more pressure to provide guidance. As a result, changing guidance practice is something more likely to be specifically approved by the entire board compared to larger companies.] And here are some practice pointers that Bass, Berry & Sims recently provided: • Announcement of Suspension/Discontinuation of Guidance - Typically, companies suspending guidance do so in conjunction with a quarterly or annual earnings release. In the announcement, companies commonly refer to the uncertainty created by the current economic environment and do not give an indication whether or when EPS guidance will resume. In general, statements that bind the company to resume guidance or give any indication of when it will be resumed should be avoided. And, if guidance is being eliminated due to concerns broader than the current economic environment—for instance, because the company has concluded quarterly guidance creates too much of an emphasis on short-term performance—then the announcement should make clear that the discontinuation is permanent. • Metrics Provided in Lieu of EPS - Companies in the process of eliminating guidance will want to consider what, if any, forward-looking metrics they will provide in future earnings releases and communications with analysts. The company's disclosure committee will need to deliberate with an eye toward providing forward-looking metrics that will be useful to analysts, as analysts will continue to publish earnings estimates even in the absence of company-provided EPS guidance. Practices here vary significantly by company and industry. For instance, some companies that have eliminated guidance still provide revenue, same-store sales or operating margin projections. Others focus on metrics between the top and bottom lines, such as projected SG&A expenses or capital expenditures. Analysts will expect that the substitute metrics (if any) that are initially provided in lieu of EPS projections will continue to be provided in future periods. Therefore, although not legally obligated to continue providing such forward-looking information, it is important for the company's disclosure committee to determine whether substitute metrics can comfortably be provided on an ongoing basis. • Regulatory Considerations - Because of their need to produce earnings estimates, analysts will continue to probe for color as to the company's future outlook. Thus, the company and its spokespersons should keep in mind Regulation FD's restriction against selective disclosure of

26

material, non-public information. Additionally, even if EPS guidance is suspended, companies should continue to include appropriately tailored forward-looking statement disclaimers in both their earnings releases and analyst presentations. The Box: Updating Guidance Mid-Quarter—and the Duty to Update The topic of updating guidance in the midst of a quarter is a timely topic as a number of companies recently have issued earnings warnings (or at least considered doing so). If it is a “big miss,” companies often are motivated to issue a highlevel update in an attempt to cut-off a plaintiff’s class several weeks before earnings are scheduled to be released - even though there may not be a true “duty to update.” Below is a typical question and answer on this topic: Question: Over the past several months, it appears that an increasing number of companies have updated their guidance mid-quarter or pre-released results after the quarter-end. Are these companies at risk of assuming a duty to update and does this suggest a trend in providing updates? Or is this an aberration that is attributable to companies updating their guidance based on the unprecedented economic conditions? Answer: The recent spate of unscheduled earnings guidance updates is aberrational in that there have been many of them in a relatively short time-frame (no doubt due to the many calendar year reporting companies adjusting their assumptions on account of the significant deterioration in the economy and a greater uncertainty of forecasting the future). While the exact scope of the "duty to update" is not settled under the federal securities law, the general rule is that there is no duty to update ordinary earnings guidance—but ultimately it's a facts and circumstances analysis. It's also helpful—but not dispositive—that a company disclaim an obligation to update the guidance it provides. A history of frequent unscheduled updates by a company would seem to set the groundwork for a reasonable expectation by investors for future updates. Therefore, on the margin, it puts a company more at risk for a finding of a duty to update. On the whole, we’re not seeing a trend toward providing more frequent updates. But we are seeing more companies giving up on providing earning guidance (at least for now). Maybe, for NYSE companies, the recent unscheduled earnings updates were made on account of dutiful compliance with Section 202.06(A) of the NYSE Listed Company Manual, which states that "[s]hould subsequent developments indicate that performance will not match earlier projections, this too should be reported and explained." But we doubt it.

C. Apples to Apples: A Template for Reporting Quarterly Earnings, by the CFA Center for Financial Market Integrity CFA Institute Centre for Financial Market Integrity/ Business Roundtable Institute for Corporate Ethics

Apples to Apples: A Template for Reporting Quarterly Earnings

Earnings Guidance: The Current State of Play

27

i

Co-Sponsors: CFA Institute Centre for Financial Market Integrity

Business Roundtable Institute for Corporate Ethics

Co-Authors Kurt N. Schacht, CFA, JD Managing Director CFA Institute Centre for Financial Market Integrity Dean Krehmeyer Executive Director Business Roundtable Institute for Corporate Ethics Tom Larsen, CFA Senior Policy Analyst CFA Institute Centre for Financial Market Integrity Matthew Orsagh, CFA Senior Policy Analyst CFA Institute Centre for Financial Market Integrity

©2007 CFA Institute, Business Roundtable Institute for Corporate Ethics The mission of the CFA Institute Centre for Financial Market Integrity is to be a leading voice on issues of fairness, efficiency, and investor protection in global capital markets and to promote high standards of ethics, integrity, and professional excellence within the investment community. Its sponsoring organization, CFA Institute, is the 89,000member, not-for-profit organization that awards the Chartered Financial Analyst® designation worldwide. CFA Institute was known as the Association for Investment Management and Research (AIMR) from 1990 through early 2004 and before that was two separate organizations with roots going back to 1947. More information can be found at www.cfainstitute.org.

© 2 0 0 7 C FA I N ST I T U T E 28

The Business Roundtable Institute for Corporate Ethics is an independent entity established in partnership with Business Roundtable—an association of chief executive officers of leading corporations with a combined workforce of more than 10 million employees and $4.5 trillion in annual revenues— and leading academics from America’s best business schools. The Institute, which is housed at the University of Virginia’s Darden Graduate School of Business Administration, brings together leaders from business and academia to fulfill its mission to renew and enhance the link between ethical behavior and business practice through executive education programs, practitioner-focused research, and outreach. More information on the Institute can be found at www.corporate-ethics.org.

ISBN: 978-1-932495-62-1 (PDF)

1

Apples to Apples A Template for Reporting Quarterly Earnings March 2007

INTRODUCTION AND CALL TO ACTION In July 2006, the CFA Institute Centre for Financial Market Integrity (the Centre) and the Business Roundtable Institute for Corporate Ethics (the Institute) issued a report, “Breaking the Short-Term Cycle,” which for the first time addressed the issue of “short-termism”—corporate and investment decision making based on short-term earnings expectations versus long-term value creation for all stakeholders—from a unique cross-group perspective.1 The report drew on insights from thought leaders of the corporate issuer, analyst, asset and hedge fund manager, institutional investor, and individual investor communities to confirm what the academic research suggests: namely, that the obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns, and impeding efforts to strengthen corporate governance.

SUMMARY OF RECOMMENDATIONS from “Breaking the Short-Term Cycle” Corporate leaders, asset managers, investors, and analysts should: 1. 2. 3. 4.

5.

Reform earnings guidance practices: All groups should reconsider the benefits and consequences of providing and relying upon focused, quarterly earnings guidance and each group’s involvement in the “earnings guidance game.” Develop long-term incentives across the board: Compensation for corporate executives and asset managers should be structured to achieve long-term strategic and value-creation goals. Demonstrate leadership in shifting the focus to long-term value creation. Improve communications and transparency: More meaningful, and potentially more frequent, communications about company strategy and longterm value drivers can lessen the financial community’s dependence on earnings guidance. Promote broad education of all market participants about the benefits of long-term thinking and the costs of short-term investing.

This report, “Apples to Apples: A Template for Reporting Quarterly Earnings,” seeks to advance the specific principles and recommendations from the initial work in confronting short-termism. Specifically, the report analyzes the role and impact of quarterly earnings releases in light of two of our key principles related to combating short-termism: 1) reforming earnings guidance practices and 2) improving communications and transparency.

1 “Breaking

the Short-Term Cycle” is available online at: www.cfapubs.org/loi/ccb.

© 2 0 0 7 C FA I N ST I T U T E

Earnings Guidance: The Current State of Play

29

2

Apples to Apples A Template for Reporting Quarterly Earnings There has been much discussion about the challenge investors face trying to comprehend quarterly earnings announcements. Effective March 2003, the SEC adopted Regulation G (Reg. G) to implement provisions of the Sarbanes-Oxley Act of 2002.2 Reg. G directs companies using non-GAAP financial measures in their furnished information (e.g., quarterly earning announcements) to reconcile such information to the most directly comparable GAAP measure. Reg. G was issued in response to the growing concern that quarterly earnings releases were becoming increasingly misleading and opaque in terms of actual GAAP earnings information and is intended “to provide investors with balanced financial disclosure when non-GAAP financial measures are presented.”3 While companies must now follow Reg. G requirements when disclosing or releasing material information that includes a non-GAAP financial measure, many observers continue to suggest that these requirements only partially address SEC concerns for having transparent and fair disclosures. These concerns become more apparent when one considers that companies provide their earnings releases some weeks before the formal 10-Q or 10-K filing. As part of our continuing efforts regarding short-termism, we are recommending specific refinements to the content and organization of quarterly earnings releases to improve transparency.

2 Securities

and Exchange Commission. “Conditions for Use of Non-GAAP Financial Measures.” Rel. No. 33-8176; 34-47226; FR-65; File No. S7-43-02 (22 January 2003). 3 Ibid.

3030

© 2 0 0 7 C FA I N ST I T U T E

3

RECOMMENDATIONS To better enable all financial statement users to make consistent, apples-to-apples comparisons among quarterly financial reports, we recommend that all public companies voluntarily adopt a consistent template for quarterly earnings releases. The template would provide management with a user-friendly format in which to highlight issues of importance in an informative and concise manner. These recommendations are based on a comprehensive review of quarterly earnings announcements from a number of companies and discussions with financial experts and users of financial statements. In order to improve the quality of communications between companies and investors, we strongly urge companies to issue quarterly earning reports that: End quarterly earnings guidance: The current practice of focused quarterly earnings guidance inadequately accounts for the complex dynamics of companies and their long-term value drivers. The costs and negative consequences of the current focused, quarterly earnings guidance practices are significant, including:

•

1.

unproductive efforts by corporations in preparing such guidance,

2.

neglect of long-term business growth in order to meet short-term expectations,

3.

a “quarterly results” financial culture characterized by disproportionate reactions among internal and external groups to the downside and upside of earnings surprises, and

4.

macro-incentives for companies to avoid earnings guidance pressure altogether by moving to the private markets.4

•

Include a GAAP income statement that starts at the revenue line and proceeds to net income: Although the information necessary to reconcile the text of the earnings release and the GAAP financial income statement data is often contained in the release, it is too often unnecessarily cumbersome and challenging to find and piece together. Current reconciliation tables to GAAP data are too often confusing and obscured within the earnings announcement. The GAAP statement— which could use either gross or net measures, depending on how the company normally reports—ought to 1) provide sufficient line-item information for the investor to follow the calculation from revenue to net income and 2) display shares outstanding, making it easy for investors to calculate per share figures and the per share earnings for the quarter. While companies can focus their quarterly earnings reports on any number of items, we find the primary common theme to be management discussion of adjustments to GAAP earnings.5 We assume management believes these adjustments provide a more useful picture of the company or they would not provide a discussion of them. We recommend a common format for such tables in order to improve the clarity of reconciliation between GAAP and text of the release, thereby improving communication between investor and company. The table would show the adjustments to the relevant numbers at both the company level and per share level, with pre- and after-tax information as necessary.

•

Position GAAP reconciliation tables in immediate proximity to the non-GAAP financial measures they are meant to illuminate: A concise GAAP reconciliation table should be positioned immediately after (or next to) non-GAAP earnings or income highlighted in the release. The table should clearly present the management adjustments from GAAP net income to the particular metric management has defined as most useful for understanding the financial status of the firm.

4 Further 5 Often

31

justification can be found in “Breaking the Short-Term Cycle.” referred to by management as the non-GAAP term “special items.”

© 2 0 0 7 C FA I N ST I T U T E

Earnings Guidance: The Current State of Play

31

4

•

Include a balance sheet and statement of cash flows: A balance sheet and statement of cash flows, along with any relevant reconciliation tables, should be included in the release. In addition, we encourage expanded discussion of balance sheet and cash flow items as appropriate. The balance sheet and cash flow information should be sufficiently representative so that it is possible to reconcile income statement items that have a direct cause or effect on the balance sheet or cash flow statement. For example, changes in interest expense on the income statement cannot be fully reconciled without the information on the balance sheet about the level of debt. Full display of financial information, including GAAP reconciliations, will support efforts to improve communication. SEC statements have indicated an increased scrutiny of “non GAAP financial measures that eliminate the effect of recurring items by describing them as nonrecurring . . . Merely labeling an item as non-recurring does not make it so.”6

•

Place information consistently: While we acknowledge the need for flexibility and the variety of considerations related to the release of corporate information, we encourage the consistent placement of all tables and reconciling information within the release. Specifically, we recommend placement of such information at the front or the end of all future quarterly releases.

6 See

“Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures,” prepared by staff members in the Division of Corporation Finance, U.S. Securities and Exchange Commission, Washington, D.C., Question 9.

3232

© 2 0 0 7 C FA I N ST I T U T E

5

TEMPLATE FOR REPORTING QUARTERLY EARNINGS The following example provides a version of the template described earlier in the form of a third quarter earnings announcement for a fictitious firm, XYZ Company. In this announcement, the company has certain earnings and income that management has highlighted. We include the opening paragraphs from XYZ Company’s announcement. We do not include the full GAAP financial statements for the quarter or year to date because these would not change from what is currently reported in the typical earnings announcement.

XYZ COMPANY REPORTS THIRD QUARTER EARNINGS FROM CONTINUING OPERATIONS OF $0.97 PER SHARE • • • •

Revenue Grew by 3.3% to $10.8 Billion from the Quarter Ended 30-Sep-05 to the Quarter Ended 30-Sep-06. GAAP Earnings from Continuing Operations Improved by $0.06 Per Share from the Quarter Ended 30-Sep-05 to the Quarter Ended 30-Sep-06. Results Were Positively Impacted by Net Adjustments to GAAP Earnings of $0.03 Per Share for Special Items. Discontinued Operations Contributed $0.05 Per Share to Overall Earnings.

New York – Dec. 15, 2006 – XYZ Company (NYSE: XYZ) today reported diluted GAAP earnings per share from continuing operations (EPS) of $0.97 for the third fiscal quarter of 2006, compared with $0.91 in the third fiscal quarter of 2005. Last year’s results included net charges of $0.15 per share related to charges from Hurricane Katrina, as well as early retirement of debt, restructuring, and divestiture charges. Revenue in the third quarter totaled $10.8 billion, with organic revenue growth of 2 percent. Cash flow from operating activities was $2.0 billion, and the company generated free cash flow of $1.5 billion in the quarter.7 During the fourth quarter, the company entered an agreement to sell the Widget Division. The division has been classified as a discontinued operation for the quarter, and results are reported accordingly. Widget revenue was $625 million, and operating income was $103 million for the quarter. The comparable adjustments for the previous quarter ending 30-Sep-05 would have been $552 million in revenue and $94 million in operating income. The company determined to divest the division due to underperformance related to other company divisions and because it no longer fit the overall business strategy. In the current quarter, EPS from continuing operations included net charges of $0.15 per share. During the quarter, the company sold some plant assets no longer required for operations and resolved certain legacy legal matters that resulted in $0.07 per share of income. Included in this income were asset sales of $0.05 per share and a court award from a legal matter of $0.02 per share. Both adjustments to charges and income are reflected in the following adjustments to GAAP net income table. For the year to date, the company had revenue of $xxx billion, with net income of $xxx. etc. Financial tables follow.

7 Cash flow from operations would be displayed in the cash flow statement, and a reconciliation table to free cash flow would also be provided. While we recommend that the free cash flow reconciliation table be provided near the discussion of such items, because it is not directly related to a discussion of GAAP earnings, it could also be placed with all other financial tables.

33

© 2 0 0 7 C FA I N ST I T U T E

Earnings Guidance: The Current State of Play

33

6

XYZ Company Condensed Statements of Income ($ in millions) Quarter ended Net revenue Operating expenses (COS, SG&A, D&A, other)

30-Sep-06

30-Sep-05

10,826 7,685

10,476 7,406

Operating income Interest income Interest expense Other income

3,141 4 (224) 18

3,070 36 (257) (97)

Pre-tax income Income taxes Minority interest

2,939 882 5

2,752 798 5

Net income from continuing operations Income from discontinued operations (after tax)

2,052 110

1,949 94

Net income

2,162

2,043

Effective tax rate Diluted shares outstanding

30.0% 2,125

29.0% 2,150

0.97 0.05 1.02

0.91 0.04 0.95

EPS from continuing operations – diluted EPS from discontinued operations – diluted EPS – diluted

XYZ Company Management Adjustments to GAAP Net Income ($ millions) For quarter ended 30-Sep-06 Management adjustments to GAAP net income

Pre-tax adjustment

Taxes

After-tax adjustment

Per share adjustment

2,162

1.02

GAAP net income Adjustments to expenses Disaster recovery Early retirement of debt Restructuring Charge for divestitures

279 114 54 14

84 34 16 4

195 80 38 10

0.09 0.04 0.02 0.00

Subtotal

461

138

323

0.15

Adjustments from income Asset sales Court award from legal case

153 67

46 20

107 47

0.05 0.02

Subtotal

220

66

154

0.07

Total adjustments to earnings, continuing operations Income from discontinued operations

241 85

72 (25)

169 110

0.08 0.05

Management adjustments to GAAP net income

156

97

59

0.03

2,221

1.05

Adjusted Non-GAAP net income

XYZ Company Balance Sheets XYZ Company Statements of Cash Flows XYZ Company Segmental or Other Financial Statement Information

3434

© 2 0 0 7 C FA I N ST I T U T E

D. Long-Term Value Creation: Guiding Principles for Corporations and Investors, The Aspen Institute’s Business and Society Program

LONG-TERM VALUE CREATION: GUIDING PRINCIPLES FOR CORPORATIONS AND INVESTORS

35

Earnings Guidance: The Current State of Play

35

The Aspen Institute’s Corporate Values Strategy Group (CVSG) is dedicated to re-asserting long-term orientation in business decision-making and investing. Members of the CVSG share concern about excessive short-term pressures in today’s capital markets that result from intense focus on quarterly earnings and incentive structures that encourage corporations and investors to pursue short-term gain with inadequate regard to long-term effects. Short-termism constrains the ability of business to do what it does best – create valuable goods and services, invest in innovation, take risks, and develop human capital. CVSG members believe that favoring a long-term perspective will result in better business outcomes and a greater business contribution to the public good. The Aspen Principles offer guidelines for long-term value creation for both operating companies and institutional investors. The Principles were created in dialogue with CVSG members who—as leaders in both investment and business—sought to identify common ground from many sources, including the Business Roundtable, Council of Institutional Investors, CalPERS, CED, TIAA-CREF and others. To fully understand the spirit and nature of the Principles, it should be noted that: 1. The Principles are not intended to address every issue of contemporary corporate governance, but instead are designed to drive quickly to action in areas that all parties agree are critically important. CVSG members share a deep concern about the quality of corporate governance and favor effective communication between and among executives, boards, auditors, and investors. CVSG members will continue to engage in independent activities related to corporate governance issues not addressed here. 2. In drafting these Principles, members of the CVSG sought consensus and agreed that an overly-prescriptive approach would slow progress. The Principles are thus offered as guidelines, and are not detailed at a tactical level. Investors and companies, especially boards of directors, have the opportunity to innovate and adapt them to meet individual and evolving circumstances. The Aspen Principles address three equally important factors in sustainable long-term value creation: metrics, communications, and compensation.1

1. DEFINE METRICS OF LONG-TERM VALUE CREATION

• managing relationships with customers, regulators, employees, suppliers, and other constituents, and

Companies and investors oriented for the long-term use forward-looking incentives and measures of performance that are linked to a robust and credible business strategy. Long-term oriented firms are ‘built to last,’ and expect to create value over five years and beyond, although individual metrics may have shorter time horizons. The goal of such metrics is to maximize future value (even at the expense of lower near-term earnings) and to provide the investment community and other key stakeholders the information they need to make better decisions about long-term value.

• maintaining the highest standards of ethics and legal compliance.

In pursuit of long-term value creation, companies and investors should… 1.1 Understand the firm-specific issues that drive longterm value creation. 1.2 Recognize that firms have multiple constituencies and many types of investors, and seek to balance these interests for long-term success. 1.3 Use industry best practices to develop forward-looking strategic metrics of corporate health, with a focus on: • enhancing and sustaining the value of corporate assets, • recruiting, motivating, and retaining high-performing employees, • developing innovative products, 36

1.4 De-emphasize short-term financial metrics such as quarterly EPS and emphasize specific forward-looking metrics that the board of directors determines are appropriate to the long-term, strategic goals of the firm and that are consistent with the core principles of long-term sustainable growth, and long-term value creation for investors. 2. FOCUS CORPORATE-INVESTOR COMMUNICATION AROUND LONG-TERM METRICS Long-term oriented companies and investors are vigilant about aligning communications with long-term performance metrics. They find appropriate ways to support an amplified voice for long-term investors and make explicit efforts to communicate with long-term investors.2 In pursuit of long-term value creation, companies and investors should… 2.1 Communicate on a frequent and regular basis about business strategy, the outlook for sustainable growth and performance against metrics of long-term success. 2.2 Avoid both the provision of, and response to, estimates of quarterly earnings and other overly shortterm financial targets. 2.3 Neither support nor collaborate with consensus earnings programs that encourage an overly short-term outlook.

3. ALIGN COMPANY AND INVESTOR COMPENSATION POLICIES WITH LONG-TERM METRICS Compensation at long-term oriented firms is based on long-term performance, is principled, and is understandable. Operating companies align senior executives’ compensation and incentives with business strategy and long-term metrics. Institutional investors assure that performance measures and compensation policies for their executives and investment managers emphasize long-term value creation. In pursuit of long-term value creation, companies and investors should implement compensation policies and plans, including all performance-based elements of compensation such as annual bonuses, long-term incentives, and retirement plans, in accordance with the following principles…

3.3 What is the Appropriate Structure of Compensation? Compensation that supports long-term value creation… a) Promotes the long-term, sustainable growth of the firm rather than exclusively short-term tax or accounting advantages to either the firm or employee. b) Requires a meaningful proportion of executive compensation to be in an equity-based form. c) Requires that senior executives hold a significant portion of their equity-based compensation for a period beyond their tenure.3 d) Prohibits executives from taking advantage of hedging techniques that offset the risk of stock options or other long-term oriented compensation.4

3.1 How are Compensation Plans Determined and Approved? Executive compensation is properly overseen by a compensation committee of the board of directors. The board recognizes that…

e) Provides for appropriate “clawbacks” in the event of a restatement of relevant metrics.

a) The compensation committee is comprised solely of independent directors with relevant expertise and experience, and is supported by independent, conflict-free compensation consultants and negotiators.

g) Ensures that all retirement benefits and deferred compensation conform to the general goals of the compensation plan.

b) The compensation committee calculates and fully understands total payout levels under various scenarios. c) Boards and long-term oriented investors should communicate on significant corporate governance and executive compensation policies and procedures. d) Careful strategic planning, including planning for executive succession, helps the board retain a strong negotiating position in structuring long-term compensation. The succession planning process is disclosed to investors. 3.2 What are Executives Compensated For? Corporate and investor executives and portfolio managers are compensated largely for the results of actions and decisions within their control, and compensated based on metrics of long-term value creation [see Principle #1].

f) Requires equity awards to be made at preset times each year to avoid the appearance of market timing.

3.4 How Much Are Corporate and Investor Executives Compensated? Corporations and society both benefit when the public has a high degree of trust in the fairness and integrity of business. To maintain that trust, the board of directors… a) Ensures that the total value of compensation, including severance payments, is fair, rational and effective given the pay scales within the organization, as well as the firm’s size, strategic position, and industry. b) Remains sensitive to the practical reality that compensation packages can create reputation risk and reduce trust among key constituencies and the investing public. 3.5 How is Compensation Disclosed? 5 Public disclosure, fully in compliance with SEC rules, includes, in clear language… a) Individual and aggregate dollar amount of all compensation afforded to senior executives, under various scenarios of executive tenure and firm performance. b) The compensation philosophy of the board and the specific performance targets that promote the creation of sustainable value in the long-term. June 2007

1. As this document is a reflection of existing sources, the greatest level of detail is offered on executive compensation. See the Appendix for a full list of organizations and sources of these principles. 2. In accordance with the SEC’s Regulation Fair Disclosure 3. However, there may be circumstances in which boards should allow the sale or transfer of an executive’s equity to accomplish purposes that do not alter the long-term incentive nature of the compensation. 4. In situations where senior executives are permitted to make personal equity trades that relate to their compensation, such trades should be fully disclosed ahead of time. 5. The new Compensation Discussion and Analysis requirements address disclosure requirements of the SEC.

37

Appendix Sources of the Aspen Principles 1. 2. 3. 4. 5. 6. 7. 8.

Business Roundtable Institute for Corporate Ethics and CFA Centre, Breaking the Short Term Cycle Business Roundtable, Principles of Executive Compensation CalPERS, Corporate Governance Core Principles and Guidelines Committee for Economic Development, Built to Last: Focusing Corporations on Long-term Performance Council of Institutional Investors, Corporate Governance Policies Financial Economists Roundtable, Statement on Executive Compensation The Conference Board, Report of the Commission on Public Trust and Private Enterprise TIAA-CREF, Executive Compensation Policy

Other Resources 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24.

Buffett, 2005 Letter to the Shareholders of Berkshire Hathaway, Inc Caux Roundtable, Principles for Business Davis / McKinsey Quarterly, How to Escape the Short-Term Trap EBR Consortium, Enhanced Business Reporting Framework Gordon, If There’s a Problem, What’s the Remedy? Hodak, Letting Go of Norm Jensen, Murphy and Wruck, Executive Remuneration Kaplan and Norton, Alignment Koller, Hsieh & Rajan / McKinsey Quarterly, The Misguided Practice of Earnings Guidance Monks, Corporate Governance in the Twenty-First Century Rappaport, Ten Ways to Create Shareholder Value The Aspen Institute, Corporate Values Strategy Group working groups The Conference Board, Revisiting Stock Market Short-Termism United Nations, Principles for Responsible Investment Wachtell, Lipton, Rosen & Katz, Compensation Committee Guide and Best Practices Weil, Gotshal & Manges, Seven Things Shareholders Want Directors to Understand in 2007

THE CORPORATE VALUES STRATEGY GROUP The following individuals played an instrumental role in developing these Aspen Principles. While all contributed to discussions and/or document revisions, the listing of their name should not be construed as an endorsement of the final Principles on behalf of either themselves or their organization. Herb M. Allison, Jr., TIAA-CREF Beth A. Brooke, Ernst & Young Fred Buenrostro, CalPERS John J. Castellani, Business Roundtable Shelley J. Dropkin, Citigroup, Inc. J. Michael Farren, Xerox Corporation (retired) Margaret M. Foran, Pfizer Inc. Abe Friedman, Barclays Global Investors Richard Goodman, PepsiCo, Inc. Julie M. Gresham, New York State Common Retirement Fund Patrick W. Gross, The Lovell Group Consuelo Hitchcock, Deloitte & Touche Suzanne Nora Johnson, Goldman Sachs & Company Jeffrey B. Kindler, Pfizer Inc. Robert Kueppers, Deloitte & Touche USA LLP

David Langstaff, Olive Group Thomas J. Lehner, Business Roundtable Ira Millstein, Weil, Gotshal & Manges LLP Steve Odland, Office Depot John F. Olson, Gibson, Dunn & Crutcher LLP William Patterson, Change to Win Charles Prince, Citigroup, Inc. James H. Quigley, Deloitte & Touche USA LLP Judith Samuelson, Aspen Institute Henry B. Schacht, Warburg Pincus Damon Silvers, AFL-CIO John C. Wilcox, TIAA-CREF Christianna Wood, CalPERS Ann Yerger, Council of Institutional Investors

The mission of the Aspen Institute is to foster enlightened leadership, the appreciation of timeless ideas and values, and open-minded dialogue on contemporary issues. Through seminars, policy programs, conferences and leadership development initiatives, the Institute and its international partners seek to promote the pursuit of common ground and deeper understanding in a nonpartisan and non-ideological setting. 38

About the Authors Robert J. Kueppers is deputy chief executive officer of Deloitte LLP and has more than 30 years of professional experience. He is responsible for all regulatory and public policy matters, and provides direction for the quality, risk, and legal affairs of the organization. He is also a vice chairman of Deloitte LLP and serves major clients of Deloitte in an advisory capacity. Mr. Kueppers previously served as the senior technical partner with Deloitte & Touche LLP in its National Office. Prior to that, Mr. Kueppers led the professional practice group, served as the national director of SEC services and as the national director of independence. From 1992 to 1996, Mr. Kueppers was the chief financial officer of an SEC-reporting manufacturing company in New York. In the mid 1980s, Mr. Kueppers was a professional accounting fellow in the Office of the Chief Accountant at the SEC. Mr. Kueppers is a member of Yale School of Management’s board of advisors for the Millstein Center for Corporate Governance and Performance at the Yale School of Management; he is also a member of the University of Minnesota’s Carlson School of Management board of overseers; additionally, he is a trustee and past chairman for the SEC Historical Society. He was recently recognized by Directorship magazine as one of the 100 most influential professionals in corporate governance and in the boardroom. He can be reached at [email protected]. Nicole M. Sandford is a partner in the Deloitte Center for Corporate Governance where she leads the firm’s board advisory practice. Ms. Sandford specializes in education and governance consulting related to board and committee practices. Previously, she was part of Deloitte's national office focused on corporate governance research. She played a critical role in the development of the Deloitte Center for Corporate Governance. Ms. Sandford is a member of the board of directors of the Society of Corporate Secretaries and Governance Professionals (SCSGP), and is the co-chair of the Financial Women’s Association’s directorship and corporate governance committee. She is the founder of Deloitte's Diversifying the American Board program. In 2008, Ms. Sandford was named a “Rising Star of Governance” by The Millstein Center for Corporate Governance and Performance. Ms. Sandford has extensive experience in Deloitte & Touche LLP's audit practice, focused primarily on publicly traded SEC registrants in the technology and telecommunications industries. She can be reached at [email protected].

Thomas Thompson, Jr. is a research associate at Financial Executives Research Foundation, Inc. He received a baccalaureate of arts degree in economics from Rutgers University and a baccalaureate of arts degree in psychology from Montclair State University. Prior to joining FERF, he held positions in business operations and client relations at NCG Energy Solutions, AXA-Equitable, and Morgan Stanley Dean Witter. Tom can be reached at [email protected] or 973-765-1007.

The authors would like to acknowledge Maureen Errity, Consuelo Hitchcock, Misty Jenkins-Saldi, and Ana Valentin of Deloitte and Bill Sinnett of FERF for their contributions to this report.

Financial Executives International (FEI) is registered with the National Association of State Boards of Accountancy (NASBA), as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be addressed to the National Registry of CPE Sponsors, 150 Fourth Avenue North, Suite 700, Nashville, TN 37219-2417. Web site: www.nasba.org Instructional method: Self-study Recommended CPE Credits: 1.00 Experience Level: Intermediate Prerequisites/advance preparation: General knowledge of earnings guidance Field of Study: Social Environment of Business This self-study program requires that you read this report then take a multiple choice exam. Once you have downloaded and read this report you may use the link below to access the exam via the new FEI CPE Center. From the CPE Center home page, click on incomplete credits on the left side of the page to access the review and final examination questions. Upon completion of the final exam you will be asked to complete a program evaluation. This evaluation must be completed in order to receive your CPE credit(s). http://www.financialexecutives.org/cpe For FEI CPE credits, one credit hour equals 50 minutes according to NASBA guidelines. Some states boards may differ on how many minutes constitute a credit hour. Contact your state board for more information. If you have any additional questions, please contact Tom Thompson, FERF Research Associate, at 973-765-1007. The programs Learning Objectives are: 1. To provide practical professional education on earnings guidance. The report highlights current issues related to the practice of providing quarterly forward-looking earnings guidance. In addition, it reviews previously published reports on the subject of earnings guidance and offers insights from companies that do and do not provide quarterly forwardlooking earnings guidance. 2. To learn the advantages and disadvantages of providing forward-looking earnings guidance. Is stock price volatility a consequence of providing or not providing forward-looking earnings guidance? 3. To learn what alternatives to forward-looking earnings guidance are being proposed. Organizations such as the Aspen Institute, the Centre for Financial Market Integrity (CFA Institute), and the Committee for Economic Development (CED) have each published reports that offer companies an alternative to quarter forward-looking earnings guidance.

40

About the Sponsor: Deloitte Deloitte & Touche, one of the nation's leading professional services firms, provides accounting, assurance and advisory, tax, and management, financial and human capital consulting services through nearly 30,000 people in more than 80 U.S. cities. Deloitte & Touche is dedicated to helping our clients and our people excel. Known as an employer of choice for innovative human resources programs, Deloitte & Touche has been recognized as one of the "100 Best Companies to Work For in America" by Fortune magazine for six consecutive years. Learn more about Deloitte & Touche at www.deloitte.com.

About Financial Executives Research Foundation, Inc. Financial Executives Research Foundation, Inc. is the research affiliate of Financial Executives International. Financial Executives Research Foundation is the non-profit 501(c)(3) research affiliate of FEI. FERF researchers identify key financial issues and develop impartial, timely research reports for FEI members and non- members alike, in a variety of publication formats. The Foundation relies primarily on voluntary tax-deductible contributions from corporations and individuals.

The views set forth in this publication are those of the author and do not necessarily represent those of the Financial Executives Research Foundation Board as a whole, individual trustees, employees, or the members of the Advisory Committee. Financial Executives Research Foundation shall be held harmless against any claims, demands, suits, damages, injuries, costs, or expenses of any kind or nature whatsoever except such liabilities as may result solely from misconduct or improper performance by the Foundation or any of its representatives. This and more than 80 other Research Foundation publications can be ordered by logging onto http://www.ferf.org. Copyright © 2009 by Financial Executives Research Foundation, Inc. All rights reserved. No part of this publication may be reproduced in any form or by any means without written permission from the publisher. International Standard Book Number 978-1-61509-009-9 Printed in the United States of America First Printing Authorization to photocopy items for internal or personal use, or the internal or personal use of specific clients, is granted by Financial Executives Research Foundation, Inc. provided that an appropriate fee is paid to Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923. Fee inquiries can be directed to Copyright Clearance Center at 978-750-8400. For further information please check Copyright Clearance Center online at http://www.copyright.com.

© 2009 Deloitte Development LLC. Member of Deloitte Touche Tohmatsu