Catch 22

Joseph Heller wrote the novel Catch 22 in 1962. It was a time when people started their careers in, and retired from, the same company. Variable pay was a remuneration practice limited to salesmen. Stock options were as far away from human imagination as the Internet. So Heller had to write a whole book on the concept called Catch 22. It caught the fancy of the world and the term became synonymous with "a situation from which there was no escape as it involved mutually conflicting or dependent conditions (Oxford English dictionary)".

If 1962 was fast forwarded to 2002, Heller would not have had to write a whole book on Catch 22. All he had to do was to direct people's attention to the listing requirements of stock exchanges that need quarterly disclosure of financial results.

All pundits of Business Ethics and Corporate Governance are unanimous that good governance is about thinking and working long term. They argue vehemently against short-term styles of management as these go against the interests of the shareholders and investors. They view PE-owned companies with circumspection for the same reason. Common sense and intuition indicate that these views are valid and have a lot of truth in them. How come we got into into the quagmire of quarterly reporting? To protect investors indeed.

Quarterly reporting started as an investor friendly devise meant to minimise potential shocks being delivered at the end of the year. Instead it has become the root cause of major governance earthquakes. Managements run from quarter to quarter trying to improve on the previous ones. Revenues are over-stated and costs understated. This sets in a motion a spiral that moves only upwards as more fabrication is needed to grow on an already fabricated base. R&D investments are cut back and new launches withdrawn from store shelves if they do not succeed within two months. Innovative financial derivatives are created to boost profits and phenomena like sub-prime make Enron and Worldcom look like small time tricksters.

In this quarterly circus, the analysts and stock market gurus wield enormous power. They can either dump a stock based on one bad quarter, or play God and give the company a few more quarters to perform. They love phrases like "the long-term is the aggregation of quarters" or "in the long-term everyone is dead". In this scenario, a company that says that it has an excellent long-term plan but the outlook for the next few quarters is poor would be like a piece of meat in front of a hungry lion. So what is a manager supposed to do in this situation, except focus on the short term?

Would you think that stock market regulators are not aware of these stark issues. Of course they do. Can they think of moving the reporting to once a year instead of quarterly? Of course not, we live in a global information age where a year is too long and stock markets would lose their dynamism in that case. Can the reporting evolve into a combination of long and short term performance indicators? No, this becomes too subjective and complicated to monitor.

We seem totally bound by a requirement we have invented. Can one think of a better example for illustrating Catch 22?

Footnote: Unlike in Heller's novel, the characters in this drama are not fictitious.