outside-the-box-heres-how-the-sec-should-decide-if-companies-should-report-earnings-only-every-6-months

Outside the Box: Here’s how the SEC should decide if companies should report earnings only every 6 months

Finance

The Securities and Exchange Commission has set a March 21 deadline for public comments on possible changes to its current financial reporting requirements for U.S. publicly traded companies.

Partly in response to a request from President Trump, the SEC is suggesting possibilities for reducing the burden of quarterly financial reporting while keeping the benefits of investor protection and market integrity. The SEC’s ideas and its request for public comments on those ideas are consistent with the Trump administration’s emphasis on reducing the burden of financial regulation.

To help answer this question, the SEC should embrace benefit-cost analysis in a serious way that sets a standard for other U.S. financial regulatory agencies.

Critics of financial regulation and its burdens advocate aggressive use of benefit-cost analyses as part of the regulatory process. For example, the Republican-controlled House of Representatives passed legislation in 2017 requiring such analyses for every major financial regulation. And the Financial Stability Oversight Council (FSOC) has recently proposed requiring a cost-benefit assessment for the designation of nonbanks as systemically important financial intermediaries (SIFIs).

But the cultures within the financial agencies have resisted such steps; their defenders often claim that the analyses can’t be done.

Both sides have a point. Economics principles suggest that benefit-cost analysis should guide regulation, contributing to objective standards that underpin trust in the rule-making process and in the resulting regulations as well. At the same time, measuring benefits and costs is very difficult for a wide range of financial regulations that are necessary and appropriate. For example, in the wake of the 2007-2009 financial crisis, higher bank capital requirements were needed to promote safety and soundness of the financial system. But how can one precisely measure the benefits and costs of such requirements? The same applies to measuring the costs and benefits of many other regulatory initiatives, such as SIFI designation.

What to do? Start “small” — and the SEC’s question is a good place to start. Minor modifications to the frequency of financial reporting would be unlikely to trigger a financial crisis; grass is unlikely to grow in the streets of America if companies could replace the current three-month reporting requirement with reports at six-month intervals — or if they were required instead to do monthly reporting.

Moreover, assessing the merits or flaws of such modifications surely is susceptible to benefit-cost analysis. Financial facts and analysis, informed by modern financial theory and empirics, can offer objective evidence and insights about the specific benefits and costs of such changes. The experiences of other countries with well-developed financial sectors and financial markets may also be useful.

For example, by stretching out the reporting periods to six months, companies would reduce their costs by preparing reports less frequently. Offsetting this, capital markets might become less efficient when companies release information less frequently. Further, it is surely less costly for a firm to produce and distribute accurate information about itself than for others to do so. The longer the period between official reports, the greater the incentive for outsiders to undertake their more costly information production in the interim. The reverse would be true if the reporting periods were shortened to one-month intervals.

The point is not to prejudge the optimal frequency of corporate reporting, but to advocate an analytic process for making this assessment that could eventually be applied more widely. The SEC should conduct and report its initial cost-benefit analysis; commenters should be invited to respond with theirs. A virtuous circle of improvements and refinements could well follow, allowing the accumulation of knowledge to inform the ultimate policy decision.

Agreement by all parties as to the final outcome seems unrealistic: Business executives are likely to favor less frequent reporting; investor groups would favor greater frequency. But both groups could well agree that the process is worthwhile.

A successful outcome for this specific proposal could lead to future regulatory proposals — by the SEC, the FSOC, and other financial regulators — in which benefit-cost analysis would be an explicit part of the process, from the beginning. This kind of approach would be consistent with the “Foundations for Evidence-Based Policymaking Act”, which was passed by the Congress at the end of 2018.

Over the longer run, a culture that encourages benefit-cost analysis could encourage innovation in methodologies that would allow broader applications — maybe eventually to those bank capital regulations and to nonbank SIFI designations.

In this last respect, it is worth recalling that 40 years ago the idea of putting a value on the human lives that might be saved or lost as a consequence of environmental or automobile safety regulations was considered radical. Today, the “value of a statistical life” is a standard metric for the analyses of such regulations.

Read: The questions every investor should ask about Trump’s proposal to radically change how companies report earnings

Since the SEC is under no deadline for moving forward with a specific set of proposals for modifying the current financial reporting rules, there is adequate time to develop the benefit-cost process that we have described.

Many people in the current administration and in Congress claim that they favor benefit-cost analysis and evidence-based decision-making. This SEC proposal is an excellent opportunity to see if they mean it, or if they are just using the tool as an excuse to scale back appropriate regulation.

Richard B. Berner, Kermit L. Schoenholtz and Lawrence J. White are professors of economics at New York University’s Stern School of Business.