Commentary: Disclosure, or Data Glut?

When troubled Yahoo! Inc. (YHOO ) reported that it had beaten expectations by earning a penny a share in the second quarter, investors grew positively giddy. They hiked the Internet outfit's stock 9%, to nearly $19 on July 12, the day following Yahoo's earnings release, euphoric that Yahoo hadn't just broken even--as analysts had expected. The surge seemed way out of proportion. The news of that penny-a-share profit came after analysts had earlier twice lowered their estimates in the wake of management warnings. More to the point, Yahoo's second-quarter revenues came in a dismal 33% lower than last year's, and more declines were forecast. All common sense would dictate that Yahoo's actual performance was weak--very weak, as reflected in its shares' 93% decline since January, 2000. So why the sudden surge in price in July? "Overreaction," says Leonard C. Soffer, associate professor of accounting at the University of Illinois at Chicago.

It's the sort of overreaction that is increasingly common these days. With profits vaporizing amid a weakening economy, more executives at more companies have more bad news to deliver to investors than at any time in recent memory. And if that weren't challenge enough, both companies and investors are simultaneously grappling with changes in how companies are required to report under the nine-month-old Securities & Exchange Commission regulation on fair disclosure of financial information. Reg FD, as it is known, requires companies to disclose important information to a broad public, not just to a favored few on Wall Street.

The combination has led to a sea change in the amount of information--useful and otherwise--now flowing to investors, and in how the market is absorbing that information. Indeed, for all the complaints by Wall Street analysts that Reg FD would cause the financial information released to investors to dry up, the opposite seems to be the case. Reg FD, coinciding as it has with the downturn, has prompted a torrent of mid-quarter earnings "preannouncements" as companies rush to get their bad news out as early and widely as they can. By the time all the reports are in for the second quarter, U.S. companies will release more than 1,300 preannouncements, says Charles L. Hill, research director for First Call/Thomson Financial. That's up from just 555 such alerts in last year's second quarter. "It has just snowballed," says Hill.

But to what end? Has Reg FD, and the avalanche of information it has unleashed, helped make the market more efficient, by getting more information out in a more timely manner to a wider array of investors? Or has it simply created a new earnings game in which managers are skillfully ratcheting down expectations in order to minimize the damage to their stocks? While companies have always managed earnings expectations to a certain extent, the phenomenon of execs notching down the corporate goalposts, then being rewarded by investors for beating the lowered goal by a penny or so seems more prevalent by the day.

Truth be told, the answer to both those questions is probably yes. There's little doubt that in these days of shrinking profits, Reg FD is playing a huge role in the increased speed and volume with which information is getting unleashed. But there's even less doubt that it's increasing the stakes for management that mishandles the process. "It is challenging right now to be a financial executive because we're dealing with the uncertainties in the economy while balancing the increasing need from shareholders for more information," says Janet B. Haugen, chief financial officer of Unisys Corp. (UIS )

HEFTY BLOW. Most companies have quickly realized that if bad news is coming down the pike, they're better off getting it out as fully as possible, rather than having to continually warn investors that more bad news is ahead. Although the result is often a quick and hefty blow to the stock price, the alternative may be worse. According to a study of some 250 companies by the University of Illinois' Soffer, managers who put all their bad news out at once in preannouncements generally see their stocks fare 6%-7% better than those who dribble out the gloomy news. "If you piece out the bad news and only give part of your bad news at preannouncement, our study would suggest you get punished severely," says Beverly R. Walther, Soffer's co-author and an associate professor at Northwestern University's Kellogg Graduate School of Management.

Reg FD has given companies plenty of other reasons for preannouncements. If they've given out earnings projections and conditions change, investors now have the legal right to promptly know about the changes. "If the outlook is going to materially differ, we have the obligation to disclose that," says C.F. "Chip" Wochomurka, vice-president for investor relations at Cummins Inc, a maker of diesel engines in Columbus, Ind. Moreover, with investors skittish and earnings "visibility" limited, the pressures on execs to prove that they know how business is faring is intense. Says Unisys' Haugen: "We have to demonstrate that we understand what's going on."

Even Wall Street may be better off with Reg FD. A new University of Southern California-Purdue University study indicates that Reg FD has not hurt the flow of information to the market. After reviewing public announcements by nearly 1,600 firms, the study found an almost 150% increase in the average number of disclosures per firm in the fourth quarter of 2000, compared with the same period a year before. Nor has it contributed to greater price whipsawing. "We don't find any evidence that it has been the big bogeyman that people seemed to think it would be," says study coauthor Frank Heflin, an assistant professor of management at Purdue's Krannert Graduate School of Management.

Still, many analysts remain unconvinced. Edward M. Kerschner, global stock strategist for UBS Warburg, for instance, argues that rather than prompt the release of helpful information, Reg FD is plaguing the market with "unfiltered disclosure." As a result, the market is reacting to every bit of information without knowing if it is important.

Plenty of institutional investors, too, "prefer the old way," says Sally Anderson, a portfolio manager at Kopp Investment Advisors in Edina, Minn., which manages about $3.5 billion. "We are getting less information from companies," says Anderson, who specializes in growth companies. "The information flow is in bits and pieces. We pick up less incremental body language than before."

But that is precisely the point. Now smaller investors who were shut out of the club are clearly getting more information. A study by researchers at Harvard University and elsewhere found that as companies have opened up conference calls, small investors have stepped up trading while the calls are in progress. "There's no doubt that the incestuous relationships between company managements and favored analysts and investment managers has mostly been curtailed," says Fred Hickey, editor of The High-Tech Strategist, an investment newsletter in Nashua, N.H. And that's what Reg FD is all about.

By Joseph Weber

With Christopher H. Schmitt in Washington, Susan Scherreik in New York, and bureau reports

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