How Companies ‘Guide’ Markets

For companies listed on stock exchanges, communication is not optional. They need to file annual and — at least for now — quarterly reports. They must also disclose major developments, such as mergers, executive changes, and cybersecurity breaches.

But beyond this mandatory reporting focused on the past, companies also share ‘guidance’ about the future, a voluntary form of communication that often grabs as many headlines as the regulatory filings. 

“Mandatory disclosures are generally backward-looking, but people want to know how to think about the future,” said Bill Mayew, the Martin L. Black Jr. Distinguished Professor of Business Administration at Duke University’s Fuqua School of Business.

“With guidance, you give them some help.”

The problem is that guidance often needs to be interpreted. It may take the form of numerical estimates or broad projections. It can emerge in a passing comment by a CEO during a call with investors or at an industry conference, perhaps during a breakout session. It may even be conveyed through a CEO’s tone of voice or through what a manager leaves unsaid.

So what trade-offs do firms face when they consider sharing their estimates of what the future looks like?

Mayew explores those trade-offs in two recent papers: a discussion of the costs and benefits managers associate with guidance, and a study of how CEOs use promises to influence shareholders’ expectations. In a third paper, Mayew examines the limitations of commonly available guidance databases.

What companies must disclose and what they choose to reveal

Public firms need to report quarterly about their financial performance — what we call ‘earnings’ — as well as once a year in an annual report. Occasionally, they also must file reports detailing major events or incidents — the so-called Form 8-K.

These obligatory filings are regulated by the Securities and Exchange Commission (SEC) and are backward-looking snapshots of the company’s financials.

But to price firms correctly, investors and analysts also need information about plans and forecasts, something only managers know. Since there’s no mandatory disclosure about the future, companies feed this demand through a varied and sometimes informal flow of messages and releases. This guidance can be tucked in the regular earnings ‘calls’ that follow regulatory filings — for example, a CEO discusses the quarterly results and adds an estimate of where revenues and profits will stand next year.

Guidance can also be the focus of special events and industry conferences, as well as investor relations website pages and company blogs.

Since this information is voluntary, companies need to weigh the costs and benefits of revealing their forecasts.

Managing expectations

In a paper published in the Journal of Accounting and Economics, Mayew discusses the findings of a large survey of managers who provide guidance and those who don’t.

One important guidance deterrent is litigation risk, the research found. Managers may worry that investors will sue if the company’s performance falls short of its projections. By contrast, the managers surveyed did not view the possibility of revealing useful information to competitors as a major reason to avoid guidance.

“They are not giving away anything secret,” Mayew said. “Helping analysts forecast future cash flows doesn’t reveal anything proprietary about a particular product line. It’s not granular enough.”

The survey also found that managers worry that guidance can encourage analysts and investors to focus too heavily on short-term results. However, companies manage that risk in different ways. For example, managers are more willing to provide estimates about revenue and capital expenditure than about bottom-line earnings. 

“This strategy tries to tie managers less to bottom-line quarterly earnings to help foster a more long-term view of the firm,” Mayew said.

Companies also tend to provide conservative guidance, the survey found, giving them room to meet or beat more manageable targets.

Managing expectations is also central to the study of “CEO promises,” published in the Strategic Management Journal.

When CEOs share future-oriented commitments to positive outcomes, they set themselves up for possible failure and damaging consequences, Mayew and co-authors found.

Promises — which move beyond the near-term forecasting of financial statement line items — can boost confidence, attract investment and raise expectations, but they also constrain a company’s flexibility. The researchers found that CEOs make more promises when they need to build confidence — such as early in their tenure or when facing external bias — and fewer when financial constraints or uncertainty make flexibility more important.  

Importantly, at times of uncertainty, the promises they do make tend to have longer timelines and fewer details.

Detecting guidance

An analyst or researcher trying to understand what a company has in mind for the future can find guidance from many sources: earnings-call transcripts, press releases, investor presentations, conference remarks, and other communications.

In “On the Usefulness of Guidance Reports,” published in the Review of Accounting Studies, Mayew and his co-authors cover more than 1.7 million guidance instances from approximately 2,000 S&P 1500 companies over 16 years.

They found that a widely used database — the I/B/E/S Guidance (IG) — does not capture a large portion of true guidance managers provide because it mainly focuses on numerical forecasts of a small set of financial statement line items.

Of the total amount of guidance provide by management, they found that 64.33% is “qualitative” rather than quantifiable.

“Qualitative guidance pertains to textual statements about a company’s business outlook, industry conditions or specific financial goals without using precise numbers,” Mayew said. “If you focus only on quantitative measures such as earnings and revenue, you miss many nonfinancial metrics that fall outside financial statements.”

Qualitative data is valuable because the language surrounding a forecast can also provide context that a number alone cannot — for example, managerial sentiment.

Mayew’s earlier research has shown that information about a CEO’s expectations can even appear in the sound of the CEO’s voice during an earnings call.

“The ways in which managers can guide analysts and investors actually takes on many forms,” he said.

A valuable tool to guide markets

Guidance helps investors and analysts estimate what a company is worth, something managers are uniquely positioned to assist with because they are the people who know the most about their business. Without guidance, analysts would develop their own forecasts, which may vary widely.

“If you let a bunch of analysts all forecast on their own, and they come up with ten different forecasts, what is the market supposed to do with that?” Mayew said.

Managing analysts’ expectations to lower this variability can help keep uncertainty and the company’s cost of capital low, he said.

But guidance also creates obligations. A forecast can expose a company to litigation risk. An earnings target can encourage short-term thinking. A public promise can raise expectations while narrowing the company’s room to change course, potentially damaging its credibility if targets are not met.

For that reason, managers often “lowball their guidance,” Mayew said, offering forecasts that they can beat or meet exactly.

“It’s a signal that you have command of your firm when you can give out a number and then deliver,” Mayew said.