Quarterly reporting attracts attention

Companies report their financial position and performance on a regular basis. Under the quarterly reporting system, companies submit financial reports four times a year. In recent years, reforms to quarterly reporting have been discussed around the world and have attracted great attention. Japan recently revised the Financial Instruments and Exchange Act and the obligation for listed companies to submit quarterly reports was abolished from April 1, 2024. As a result, quarterly reporting was integrated into disclosure in the form of earnings reports (kessan tanshin) in accordance with stock exchange regulations.

The reform to quarterly reporting was brought to the table by Prime Minister Fumio Kishida, who raised the idea of revising quarterly reporting in his policy speech on October 8, 2021.^[1] In that speech, Kishida proposed the realization of a new capitalism and stated that "it is important for companies to adopt a long-term perspective and manage their business in a way that benefits not only shareholders, but also employees and business partners," so-called "win-win for all." This statement was a reference to the myopic behavior which is the negative side of quarterly reporting. Myopic behavior refers to behavior aimed at inflating current earnings at the expense of long-term benefits (Stein, 1989).

Looking outside of Japan, the EU decided to abolish mandatory quarterly reporting in 2013 in order to reduce the disclosure burden on companies and encourage long-term investment (EC, 2013). In the United States, in 2015, the Securities and Exchange Commission (SEC) held lengthy deliberations on abolishing quarterly reporting.^[2] Former U.S. President Donald Trump called for the abolition of quarterly reporting on social media in 2018.^[3]

Two hypotheses on the impact of quarterly reporting

However, there is disagreement among researchers and experts as to whether quarterly reporting induces myopic behavior. To begin with, there are two conflicting hypotheses in regard to how corporate behavior is impacted by the increased financial reporting frequency. The first hypothesis is that frequent financial reporting increases capital market pressure for short-term performance, thereby encouraging myopic behavior. The second hypothesis is that frequent financial reporting reduces the information asymmetry between managers and investors, thus making it easier to monitor management and reducing moral hazards. Examples of moral hazards include managers prioritizing their own interests and not making business efforts. If frequent financial reporting improves the monitoring function on managers, then managerial myopic behavior would be suppressed. Considering these arguments, does quarterly reporting truly induce myopic behavior in companies?

Quarterly reporting and myopic behavior

There are studies on the effects of increased reporting frequency (for example, the introduction of quarterly reporting) on managerial myopic behavior; however, the results are inconsistent. Some studies have found that the mandatory quarterly reporting reduces corporate capital investment (Kraft, 2018), dampens innovation (Fu et al., 2020), and increases real earnings management (Ernstberger et al., 2017). Other studies have found that after the mandatory quarterly reporting, capital investment has increased (Fujitani, 2020), or found no evidence of managerial myopic behavior (Nallareddy et al., 2017; Kajüter et al., 2019). The majority of these studies have focused on countries, mainly the United States and Europe, and the results of studies may vary when the institutional environment of countries differs.

To examine this issue, I collaborated with Professor Tomoyasu Yamaguchi (Faculty of Commerce, Chuo University) to study whether quarterly reporting encourages managerial myopic behavior. Our research focused on Japanese companies, and we used real and accrual-based earnings management as proxies for managerial myopic behavior. Real earnings management is the behavior of adjusting profits through the manipulation of business activities, while accrual-based earnings management is the behavior of adjusting profits through accounting manipulation.^[4] In order to increase short-term profit, companies may engage in behavior such as increasing sales through temporary discounts, cutting R&D and advertising expenses, and reducing manufacturing costs through overproduction. Manipulation of accounting can also be used to temporarily increase profits.

Real earnings management changes corporate behavior itself in order to increase short-term profits. This has a negative impact on the long-term profitability of a company. Real and accrual-based earnings management also reduce long-term firm value by diminishing the transparency of financial reporting. Therefore, such behavior illustrates the myopic behavior of companies.

Our research showed that real and accrual-based earnings management increased after introduction of mandatory quarterly reporting, and that quarterly reporting is one factor that encourages managerial myopic behavior. These results suggest that quarterly reporting is associated with managerial myopic behavior, providing evidence to support the negative impact of quarterly reporting pointed out during deliberations on reforms to disclosure regulations. Details of the results of real earnings management are explained in Koga and Yamaguchi (2023), and details of accrual-based earnings management are explained in Yamaguchi and Koga (2023).

Impact of quarterly reporting reform and future challenges

In Japan, the requirement to submit quarterly securities reports was abolished from April 2024. Nevertheless, quarterly earnings reports (kessan tanshin) as required by stock exchange regulations remain in place. As a result, there will be no difference in reporting frequency before or after the abolition of quarterly securities reports. However, since quarterly securities reports require an audit (quarterly review) to be performed by a CPA, the elimination of those reports is likely to significantly reduce the burden on companies. Going forward, the following ex post facto verification for the impact of quarterly reporting reforms will be important in considering the appropriateness of the reforms. Specifically, the following issues are considered to exist: The first is how the function of providing information will be impacted by abolishing quarterly securities reports. Although the costs incurred by companies to provide information will be reduced, there is also the possibility that unaudited quarterly financial information will be less reliable. The second is whether the abolition of quarterly securities reports has changed the incentives for managerial myopic behavior. The third is the need for research to capture the net effects of the costs and benefits associated with reforms to quarterly reporting. A comprehensive assessment of the net effects of the revision will be important in policy evaluation.

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[1] https://www.kantei.go.jp/jp/100_kishida/statement/2021/1008shoshinhyomei.html
[2] https://www.sec.gov/news/speech/international-developments-higgins
[3] https://www.bbc.com/news/world-us-canada-45226228
[4] Real discretionary behavior is explained in detail in Do Managers Adjust Earnings Through Business Activities? (Chuo Online) by Tomoyasu Yamaguchi.

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Reference Literature

• European Commission (EC), 2013. Revised directive on transparency requirements for listed companies (transparency directive)--Frequently asked questions. Memo (12 June). https://ec.europa.eu/commission/presscorner/detail/fr/MEMO_13_544
• Ernstberger, J., Link, B., Stich, M., Vogler, O., 2017. The real effects of mandatory quarterly reporting. The Accounting Review 92 (5), 33-60. https://doi.org/10.2308/accr-51705
• Fu, R., Kraft, A., Tian, X., Zhang, H., Zuo, L., 2020. Financial reporting frequency and corporate innovation. The Journal of Law and Economics 63(3), 501-530. https://doi.org/10.1086/708706
• Kajüter, P., Klassmann, F., Nienhaus, M., 2019. The effect of mandatory quarterly reporting on firm value. The Accounting Review 94 (3), 251-277. https://doi.org/10.2308/accr-52212
• Koga, Y., Yamaguchi, T., 2023. Does mandatory quarterly reporting induce managerial myopic behavior? Evidence from Japan. Finance Research Letters 56, 104142. https://doi.org/10.1016/j.frl.2023.104142
• Kraft, A.G., Vashishtha, R., Venkatachalam, M., 2018. Frequent financial reporting and managerial myopia. The Accounting Review 93 (2), 249-275. https://doi.org/10.2308/accr-51838
• Nallareddy, S., Pozen, R., Rajgopal, S., 2017. Consequences of mandatory quarterly reporting: The UK experience. Columbia Business School Research Paper No. 17-33. https://ssrn.com/abstract=2817120
• Stein, J. C., 1989. Efficient capital markets, inefficient firms: A model of myopic corporate behavior. Quarterly Journal of Economics 104(4), 655. https://doi.org/10.2307/2937861
• Fujitani, R., 2020. Real Effects of Financial Reporting Frequency: Policy Evaluation of Quarterly Reporting Focusing on Corporate Investment Behavior. Japan Journal of Finance 40(1-2), 2-23.
• Yamaguchi, T., and Koga, Y., 2023. The Impact of Mandatory Quarterly Reporting on Accrual-Based Earnings Management. The Journal of Commerce 65(3/4), 47-81.

Yuya Koga／Associate Professor, Faculty of Commerce, Chuo University
Areas of Specialization: Accounting and Financial Accounting Theory

Yuya Koga was born in Fukuoka Prefecture in 1987. He graduated from College of Business Administration, Yokohama National University in 2011. He completed the Master’s Program in the Graduate School of Commerce and Management, Hitotsubashi University in 2013. He completed the Doctoral Program in the same graduate school in 2016. He holds a Ph.D. in commerce. He served as a Special Lecturer in the Hitotsubashi University Graduate School, and a Full-Time Lecturer and Associate Professor in the Faculty of Business Administration, Tohoku Gakuin University before assuming his current position in 2024.

His current research themes include the relationship between financial reporting and myopic behavior by corporations, and the impact of adopting IFRS.

His main written theses include “The effect of voluntary international financial reporting standards adoption on information asymmetry in the stock market: Evidence from Japan.” Research in International Business and Finance (2024, co-authored), “Does mandatory quarterly reporting induce managerial myopic behavior? Evidence from Japan.” Finance Research Letters (2023, co-authored), “Operating Leases and Credit Assessments: The Role of Main Banks in Japan.” Journal of International Accounting Research (2022, co-authored), and more. His detailed profile is available on his personal website (Japanese).

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