Contents
- 1. What did we talk about last time?
- 2. Myth busting time
- 2a. Myth 1: Companies are legally required to maximize profits due to fiduciary duty
- 2b. Myth 2: Corporate greed is is all the fault of “profit-maximizing shareholders”
- 2c. Myth 3: Investors only care about quarterly profit
- 2d. Corollary Problem 1: Why don’t shareholders just do activist work themselves?
- 2e. Corollary Problem 2: Does it have to be quarterly?
- 3f. Myth 4: We should just abolish quarterly profit reporting because it encourages short-term behaviour
- 3g. Myth 5: Investors are fundamentally greedy and short-term focused
- 4. Conclusion
1. What did we talk about last time?
In the last essay, of our ?? part series (1, 2a, ??) we talked about the evolution of company law and corporate governance.
The key lesson was that quarterly metrics were created by design and are working as intended:
- We separated the ownership and management of a company because we want people to be able to invest in and sell stocks of a company;
- This separation of ownership and management creates significant problems about information asymmetry. Therefore we created quarterly reporting to solve this problem;
- Quarterly reporting demands legibility (in order to create constant reports and provide information to company owners), which in turn means an obsessive focus on key metrics;
- Therefore an obsessive focus on quarterly profits is not a bug in capitalism. It is a highly desirable feature because without it you cannot have the separation of ownership and management of a company.
You may also remember that in the second essay, we learned that legibility destroys context. In order to have large scale systems we need standardization and consistency. But this in turn removes context and nuance.
It is the combination of these two factors (need for standardization to facilitate the separation of ownership and control combined with the consequences of standardization) that lead to what we have today.
Naturally, there will still be many (very reasonable I must say!) objections.
Why is all of this necessary in the first place? Why choose profit over any other metric? What happens if we just got rid of quarterly reporting requirements?
Online discussion on this topic is poor and people will repeat myths (often with good intentions) about how easy it is to solve capitalism if we just stopped greed for profit.
But if you want to change a system, you need to know why it came to be in the first place. So let’s go bust some myths then.
2. Myth busting time
2a. Myth 1: Companies are legally required to maximize profits due to fiduciary duty
Yeah, nah. This is absolute bullshit.
I covered this already in a separate essay: Please shut up about Fiduciary Duty.
Essentially, fiduciary duty is the requirement for Directors of a company not to misuse or abuse their position of power. This is especially important because of the separation of ownership and control of a company.
There is no such legal requirement for companies to maximize profits. Anyone who says this is completely and utterly incorrect.
It also indicates that everything else they are about to say about capitalism or corporations is extremely likely to also be wrong.
I dislike this question. Creating a faceless entity called “shareholders” to blame is like blaming immigrants for why inflation is happening.
When you have an amorphous anonymous entity that you can conveniently blame for all your problems, it makes for a great scapegoat. And convenient scapegoats are easy to create memes about.
It’s also terrible for actual policy decisions and solving the underlying problem.
So before we actually talk about profit maximizing shareholders, let’s actually talk about what a “shareholder” looks like.
When people talk about shareholders they dislike, a common example people will blame is pesky hedge funds who care about nothing but profit.
Yeah, nah.
Firstly, hedge funds don’t hold the majority of stock. The majority of stock is held by individuals who invest to save for retirement. For example:
In the U.S., 52.1% of the $34.6 trillion in retirement assets are individually funded by defined contribution pension plans, IRAs and annuities. The other 47.9% of retirement assets are funded by federal, state and local governments, as well as by defined benefit pension plans.
We therefore point out that more Americans own stocks than one would think – stocks are not just the privilege of the one percent.
Eagle eyed readers might reasonably push back and argue that this quote talks about retirement accounts and the stock market as a whole. That is fair!
But the US stock market as a whole is about $60 trillion. The exact number varies depending on which data source you use. The World Bank for example has US stocks at about $62 trillion. 1For reference, the World Bank also says all stocks globally are about $114 trillion. So retirement investing for only US individuals is 30% of everything in the world.
So retirement investment alone (~$35T) is over half the US stock market (~$60T). This is what your “average” shareholder actually looks like. It’s not some hedge fund manager twirling their Monopoly moustache thinking of how to screw people over. It’s a random average person in the US who just wants to save for retirement.
The confusion likely comes because much of this stock is not held directly by individuals. It is held in investment accounts such as pensions / 401Ks or other vehicles managed and operated by large investment corporations such as Fidelity, Vanguard, Charles Schwab, Franklin Templeton, etc.
However, even though these stocks may be held in name by investment corporations, these are fundamental assets owned by the general public.
A reasonable argument someone might make is: “Sure, over half of stocks are essentially owned by the public. But the other half might still be owned by those nasty hedge funds!”
Here, I can refer you to this research paper from the Federal Reserve Board:
On average over the sample period, hedge funds own 7% of outstanding shares for the typical firm listed on NYSE, AMEX, or NASDAQ.
So hedge funds own about 7% of the stock market. The paper also notes that for some firms this can rise to 17%. This is definitely significant. But it does not make hedge funds the primary or largest set of stock owners in the market.
So when we talk about companies trying to “maximize value” for their shareholders, don’t think about companies working for “those greedy hedge funds”. This is deliberate wording designed to skew the discussion of shareholders into an ethical or moral problem to drive emotion and outrage.
Instead, think about companies trying to maximize the return on investment for people investing for retirement.
Because that’s what a lot of this is really about. The human desire to be able to save for retirement and not get screwed over when you invest.
2a-ii. What is the impact of hedge funds?
A reasonable counterargument might be: “Okay, hedge funds might not actually own that much stock overall. However, they have an outsized influence at companies. Just look at companies changing their policies because hedge funds lobby them!”
This is a pretty good argument and it’s worth exploring. So let’s actually look at examples of how hedge funds squeeze companies, how much stock it took to lobby for change, and why this happens.
The classic example people think about is what is referred to in the industry as an “activist investors”. These are hedge funds that buy up shares, and then campaign for change at a company to boost profits.
Wendover Productions had a nice video about how Southwest Airlines was targeted by hedge funds and squeezed for money, ruining the company.
It’s a well produced video. Pity that I don’t agree with the conclusion. I’ll explain why in a bit.
So these boogeyman hedge funds must be buying majority stakes in companies in order to take control then, right? Well, Elliot Investments was the named hedge fund in the video that ruined Southwest Airlines.
They’ve been busy. Let’s look at Elliot Investments’ recent activist campaign at BP. This was recent when I first started writing this draft. I am slow at editing. This radical campaign must have been a massive takeover requiring them buying up a majority stake in order to bully the company and…
Activist investor Elliott Management has built a near 5% stake in BP and is pushing the oil company to take radical action to transform its performance, including a big divestment programme, a source familiar with the matter told Reuters on Thursday.
Elliott is engaging with the company in advance of its Capital Markets Day, scheduled for February 26, which it sees as a critical event, the person said.
It took them 5% of ownership.
For those of you unfamiliar with how corporate governance works, it takes more than 5% of shares to control a company. Shareholders of companies get to vote on issues. And you often need a majority (50%+) to actually make a change. Some companies require supermajorities to get anything done.
Okay, well, BP is one of the largest companies in the world. Maybe at a smaller company you can afford to buy out a majority or supermajority!
Sure. Elliot Management also gutted Southwest Airlines, right? That’s a much smaller company and was much beloved for not charging things like carry-on luggage fees and profit sharing with its employees! They must have bullied their way into the board room by….
Elliott Investment Management now holds 10% of Southwest Airlines’ common stock, crossing the threshold that allows the hedge fund to call a special meeting at the carrier, according to a person familiar with the matter.
Clearly, something is going on here. Despite only owning a tiny fraction of these companies, Elliot Management has a massive influence. So why is it so threatening?
Like, imagine you’re a shareholder in Southwest Airlines or BP. If hedge funds really do ruin companies and destroy all the value… you can just vote No to anything they propose. There’s literally nothing hedge funds can do to stop you from voting No to their ideas and stopping them.
So how does a hedge fund like Elliot get their proposals adopted when they only own a tiny fraction of the company?
The answer is that the votes come from the rest of the shareholders who are also fed up with management. And remember, using the US stock market as a reference, over half of shares are owned by people for the purpose of retirement.
These shares are often managed by institutional investors such as pension funds. These funds want to maximize returns on behalf of the individual investors trying to save for retirement. That’s why they will sometimes go along and vote in agreement with activist investors.
Afterall, activist investors don’t generally go after companies that are successful. Do you see any news about activist investors targeting NVIDIA and trying to replace management? No? Huh. Funny.
Why did Southwest and BP get targeted again?
Elliott’s move on BP has boosted its shares, signalling that investors are optimistic that the activist might press for changes that deliver returns.
BP CEO Murray Auchincloss is on a mission to revitalise the company and boost profits but since taking on the job last year he has faced an uphill battle to reverse the company’s underperformance.
On Tuesday he pledged to fundamentally reset the company’s strategy as it reported a 35% fall in annual profits, missing analysts’ expectations.
What about Southwest Airlines?
Southwest Airlines, which has been struggling to remain profitable since the COVID-19 pandemic, has taken steps to turn the business around, including adding seats with more leg room and dropping its marquee open seating system.
You don’t get targeted if you do a good job. You get targeted if your results are bad.
Remember, hedge funds don’t do this alone. They need to get pension funds to agree with them to be successful. And the pension funds only go along if they think this will actually be beneficial.
Activist and pension partnership also isn’t restricted to profit. That’s just what makes the mainstream news. Pension funds can care about other topics too.
Last week, an activist investor successfully waged a battle to install three directors on the board of Exxon with the goal of pushing the energy giant to reduce its carbon footprint. The investor, a hedge fund called Engine No. 1, was virtually unknown before the fight.
The tiny firm wouldn’t have had a chance were it not for an unusual twist: the support of some of Exxon’s biggest institutional investors. BlackRock, Vanguard and State Street voted against Exxon’s leadership and gave Engine No. 1 powerful support. These huge investment companies rarely side with activists on such issues.
So why does activist investing work?
This goes back to the issue of separation of ownership and control. In the modern world, any given public company has millions of ownership. It’s extremely hard for all of a company’s owners to coordinate and agree on what changes they want to make, and how to vote if they think a company is underperforming.
Get 10 people in a room and you’re going to struggle to get them to agree on what to eat. What hope do millions of shareholders that you can’t even get into a single room together have to actually force massive change at an underperforming company?
The activist investor solves this coordination problem. They bring attention to a problem at a company, and have a strong interest in solving it.
If they have a good proposal, then all other shareholders have to do is just vote Yes and enjoy the benefits for “free”. You’re not paying the activist investor for their service after all. And if their idea sucks, you vote No and nothing in life changes.
So, summing it all up, Southwest’s antiquated technology and reluctance to invest in its infrastructure led to an almost $1.5 billion loss. But then came 2023, and even as the operational meltdown faded into distant memory, the airlines financial prospects failed to reverse. In fact, they only got worse.
As United, Delta, and other US airlines booked higher and higher profits as COVID’s pent-up demand surged into a record travel period in the US, Southwest was moving in the opposite direction. After booking almost a billion in profit in 2021, 2022 saw just $539 million. Although easy to brush off as a lingering consequence of the meltdown.
But then 2023 ended and profit dipped further, just $465 million for the year. Increasingly, it appeared that Southwest’s changing fortunes were not a short-term remnant of a high-profile debacle, but actually reflective of changing market dynamics in the American airline industry.
The Downfall of Southwest Airlines (Wendover Productions, 2025)
Wendover Productions had the right idea, but drew the wrong conclusions.
Hedge funds didn’t ruin Southwest Airlines. Southwest Airlines management and its customers ruined the company.
Southwest Airlines didn’t upcharge its customers and offered lots of amenities. But that also meant making less money, and as part of that strategy it meant underinvesting in its IT infrastructure.
Customers are fickle. So after the holiday meltdown in December 2022, customers left Southwest Airlines for other companies and didn’t come back. This was a disaster, and company leadership had to change.
People will bemoan how Southwest got rid of free check-in bags, no assigned seating, etc. But at the end of the day, people voted with their wallets and said boring airlines with good IT that charge you lots of additional fees are preferable to an airline that has perks like free check-in bags but also underinvests in IT.
When you have a disaster this big, shareholders want change. Elliot was just a mechanism for shareholders to coordinate and express their dissatisfaction.
Remember: If Southwest Airlines management were credible and had a convincing business plan, the shareholders could have voted No to everything Elliot proposed!
2c. Myth 3: Investors only care about quarterly profit
Now that we know what a shareholder is, let’s talk about the profit maximization part.
This is a seductive argument. It seems that all anyone ever talks about is profit. This seems like wrong thing to do. After all:
- Why can’t we measure companies on other things like their contribution to society or employee well being?
- Why does it have to be something brutally simplistic like profit which ignores things like the human misery created in order to fuel profit?
- If the average shareholder is just the average person saving for retirement, surely they would prefer living in a nicer society?
- Doesn’t looking at profit only encourage short term behaviour?
There are several problems with this framing.
The first problem comes down to one of the fundamental points about why we have capitalism. I brought this up in the very first essay:
The fundamental problem that all economic systems need to address is scarcity. This is commonly expressed as the problem where humans have unlimited wants, but only limited resources.
This creates a natural problem: How do you decide where the limited resources should be allocated?
The problem with answering this question is that how you might want to allocate resources changes over time. So your system needs feedback loops that allow the system to naturally change itself over time.
Profit acts as an important signal used to determine how we allocate resources in the economy:
- If you can charge a higher price for something, it signals that this good or service is valuable and encourages greater production in order to meet demand;
- If you can produce something for a lower cost, it means less resources are needed. This means more resources can be allocated for other economic activity instead.
Of course, in practice this is still quite abstract. If Walmart can get you a pair of socks for $1 cheaper, that’s not literally freeing up $1 to be reallocated in the economy towards cancer research.
But if you zoom out a bit (well zoom out quite a lot)… this is true.
Why do investors care about things like stock buybacks and dividends? Don’t think of this as profit maximizing at the individual company level. Instead, think of this as extracting cash from companies that don’t need it and giving it to investors who can then reallocate it to other parts of the economy.
This means that profit maximization isn’t about the profit itself. It’s also about reallocating cash in the economy from companies that have excess cash to other areas of the economy that can use the excess cash.
Profit also signals that something is highly in demand, and that there is an opportunity for new companies to enter, provide additional supply, and “compete away” the profits.
It’s crude. It’s not very efficient. And there are so many ways to manipulate this. But… when you do things at scale, standardization removes context and nuance.
It’s a blunt instrument by design because being overly simple and crude can be a positive feature in and of itself. Simple means being cheap and straightforward. Which brings us to the next problem with this framing.
The second problem with this argument is that when measuring company performance, investors do try to look at other metrics not called profit!
For example, you might look at cashflow to determine the financial health of a company, inventory levels to look at the efficiency of working capital, expense ratios to determine cost efficiency, capital expenditure to see if the company is making the necessary investments for the future, and more.
Profit is a short-term measure. So a sophisticated investor will look at other metrics precisely to try and form a long-term picture of a company and avoid getting trapped in short-term pitfalls!
Now, a counterargument you sometimes hear is: “Okay, those aren’t profit. But aren’t they also just more financial metrics that companies will optimize against and cause modern capitalism induced misery?”
But once again, we return to the original problem of legibility. This is why I covered that as my first essay before any other topic.
To measure metrics and to allow for comparisons of performance, things need to be standardized and consistent.
The simpler a metric is:
- the easier it is to measure and track;
- the less expensive it will be to keep measuring it over time;
- the less confusion there will be about definitions and terminology;
- the harder it will be to fake or manipulate; and
- therefore the more useful the metric will actually be.
Why do we measure financial metrics such as profit, inventory, cash, etc.? Because these are comparatively straightforward and simple.2The word comparative is doing a lot of heavy lifting here, as any accountant will tell you. Next time you meet one, ask them for their favourite story about IFRS 13. And at least have the decency to buy them a stiff drink while you’re at it.
It would be great to measure companies based on their fundamental contribution and benefit to society. Afterall, the whole point of modern capitalism is to try and allocate resources to best meet the needs and wants of society!
So quick question: How are you going to measure this?
Go on, don’t be shy. What is an extremely straightforward, simple, unambiguous approach to measuring a company’s beneficial contribution to society?
Please make sure that it allows for easy comparison between different types of industries / business models and also provides a mechanism to then determine how to continuously adjust the allocation of resources between economic opportunities. The measurement mechanism also needs to be fairly cheap because if it costs more to measure this than the benefit gained by actually measuring this metric, then society is just better off not implementing this approach at all.
This is why I strongly dislike this argument. There isn’t some magic wand that would perfectly measure benefits to society that evil capitalists are ignoring to deliberately make people suffer!
The US Bureau of Labour Statistics says that about 131,000 new accountants are needed every year. This is above average compared to other jobs. The industry research firm IBIS claims that the US accounting industry alone is about $150 billion in revenue a year.
At the end of the day, accounting is about telling you if the company is making money or not, and if the money is real or made up. I’m being extremely reductive here, but at the end of the day that’s what matters.
Just to answer the basic question: “Do companies make money and can we make sure they’re not lying?” it costs America $150 billion and 131,000 new accountants a year because of how stupidly complex answering this question actually is.
Trying to measure something as complex and vague as “Does this company contribute positively to society” is going to be infinitely worse.
I assure you, if you can come up with an approach that genuinely works and you can prove that it works, you will win the Nobel Prize for Economics tomorrow.
And governments, regulators, investors, and academics do try to find ways to improve disclosure that considers more than just profit. Environmental, Social and Governance (ESG reporting) has been a hot topic in recent years. But it’s fraught with a lot of complexity and cost precisely because measuring these sorts of things is hard and expensive.
Publicly-listed companies spend, on average, between $220,000 and $480,000 on ratings-related costs per year, with their private counterparts being billed for up to $425,000, based on a survey by sustainability consulting firm ERM.
[…]
Investors, too, are spending large amounts on ESG data and ratings, with costs ranging between $175,000 and $360,000, the ERM said, although many reported having only “moderate confidence” in the accuracy and utility of these ratings.
Reuters: Companies pay up to $500,000 for sustainability ratings (Virginia Furness, March 2023)
Like many things in life, we’re not using profit because it’s perfect. We’re using it because so many other options are just worse or not possible to do.
I think this answer is important to emphasize. Oftentimes, when people think that something is bad or wrong, they assume that there must exist a “right” or “good” answer.
The reality is that for many problems, there is no good answer. Only shades of “Wow all of these answers suck, so you’re going to have to pick the answer that sucks the least.”3I will probably write an essay at some point about how metrics are selected, how to create good metrics, and how metric selection and measurement goes wrong. So while I could go in-depth about metrics and how it can distort behaviours / incentives, I will refrain from doing so here.
So in theory, if companies aren’t performing well, why can’t the shareholders just try to fix the performance themselves? After all, collectively they own enough shares to vote for change anyway. That’s why the hedge funds need them in the first place!
This is a great question. I mentioned earlier how this was difficult because of the problem of coordination. Let’s explore that it would actually take for the “average shareholder” to do activist work themselves.
We have a lot of practical problems to solve. But very broadly speaking, there are two key problems to solve:
- How do you identify when a company is underperforming?
- How do you convince other people to agree with you that a company is underperforming?
The first barrier is that the “average shareholder” is the average person saving for retirement. The average person does not follow that much news, and if they do it’s extremely unlikely to involve reading a company’s annual report.
The average person also has very little understanding or expertise to analyze business news, even if they were interested. And on top of that, would they even have the time to do so if they wanted to?
This means that when it comes to answering these three problems, it’s not going to be the “average shareholder” who will be doing this. It’s going to be the institutional investors who hold the stock on behalf of investors who will be trying to solve this problem.4So companies like Fidelity, Vanguard, etc. that I mentioned earlier. Only these large corporate entities and pension funds have the expertise, time, and interest to actually do this.
Because these are large institutions, it also means things are going to be done in the classic corporate sterile way. This means generally optimizing around clear legible metrics such as profit, cashflow, etc. rather than vague ideas such as “does good for society”.
So already we have a complication. What these institutional investors want is rarely going to exactly match what the “average person” wants. So we have bias creeping into the process already.
We now run into the second practical problem: Monitoring companies is really hard in a global environment.
Let’s use a really simple example to illustrate this point:
- Let’s pretend we only care about the 500 companies in the S&P 500. We’re not even looking at the rest of the US publicly listed companies or privately held companies at all.
- How long does it take to properly analyze the results / reports of these companies? Let’s say it takes you three hours to read the company’s own quarterly report and related industry analyst commentary
- e.g. Industry reports on developments in biomarker testing to understand what Pfizer is actually investing in and if it’s commercially viable
- With 500 companies producing 4 reports a year and 3 hours per reporting cycle, this requires 6,000 hours just to keep track of everything
- The average year has 220 working days. So you’d need about 27 hours per day just to keep track of all the reports.
- In practice, that means 3 people working 9 hours a day doing nothing but reading just to keep up with all of the reports.
You can see how this is deeply unsustainable. This is ONLY the report reading for just 500 American companies! Globally the total is over 50,000!5The World Federation of Exchanges claimed over 58,000 in 2022. So it’s likely even higher today.
We haven’t even started building out teams to set policies and standards, modeling and measuring performance for companies versus their peers, actually communicating and negotiating with these companies, etc.
How much more complex does it get when you start introducing other topics that we want large institutional investors to care about such as executive pay, board diversity, environmental impact, worker treatment, health and safety, etc.?
Just for reference: In 2017 the Financial Times reported that Vanguard, one of the largest fund managers in the world, had just 20 employees in its corporate governance team. To cover every single stock it invests in across the entire globe.
Blackrock went on a hiring spree and had… just 31. Fidelity International had 12. State Street had just 11. CalPERs, one of the largest public pension funds in the world, had 29 people on its governance team.
Now, this is strictly speaking not a perfect metric to measure. Financial performance will often be managed by the individual fund and portfolio managers, so not all duties will fall to the Corporate Governance team.
However, large funds such as Vanguard often vote as a single collective entity when it comes to major shareholder meetings. So this is still a helpful metric to understand the level of operational complexity and capacity available to actually monitor and interact with companies.
And this should hopefully make things very clear: These teams are small. This is deliberate! Afterall, pensions and fund providers try to keep costs low in a world where individual investors increasingly demand lower fees and costs.
This is a good thing! People getting lower fees means they achieve higher returns which makes saving for retirement easier!
But it also means these tiny teams don’t have a ton of bandwidth to actually scrutinize the thousands of companies these pension funds invest in at any significant level of detail.
This means that these governance and monitoring teams at large institutional investors won’t pick up on a lot of nuances. Nor do they have the bandwidth to develop comprehensive business strategies.
As a result, even if they spot underperformance occurring at a company, they won’t necessarily have good recommendations or proposals for what to do differently.
What often happens in practice is that companies will reach out to their largest shareholders to discuss their business strategy and vision for both the short-term and long-term. This can occur during formal scheduled events such as Investor Day, or ad hoc scheduled meetings that are set up between company management and investors.6For example, Activision Blizzard prior to the Microsoft takeover would meet with investors at Blizzcon since company management were all in one place. These meetings also happen at large industry conventions or events for the same reason of convenience.
The company’s investor relations and executive team will solicit feedback and have discussions. Investors may question and push management on certain topics. But there is a limit to how radical any change that comes from these meetings can be.
This is because not all investors will agree or want the same thing. So it’s a balancing act for company management to decide how to prioritize all of the different competing views.
Which conveniently is the third problem you face: Not all shareholders are going to agree if a company is underperforming. Even if they do, they might not agree on what changes to make. Trying to form a consensus is difficult.
This is especially true given just how many shareholders a company might have. For many large listed companies in the Fortune 500, outside of companies with large family / founder ownership, your top 10 shareholders might only each own single digit percentages of the company.
This means talking to each and every other large pension fund / institutional investor who owns a company’s stock is a lot of work. Work that your tiny governance team doesn’t necessarily have capacity to do.
These practical problems are why there is a “market” for activist hedge funds. Markets form when there is a problem that needs to be solved, and a willingness for people to pay to solve it.
The hedge funds do the difficult and time consuming work of actually analyzing the business in detail, contacting all of the other large shareholders, and trying to coordinate and form a consensus. The pension funds benefit from the work being done and saving costs. And the hedge fund gets “paid” not directly by the pension funds themselves, but from the profit they make from their investment.
The market is working as intended.
2e. Corollary Problem 2: Does it have to be quarterly?
Okay, so we need regular reporting to monitor management given the separation of ownership and control. But if companies have to report every quarter and risk getting smacked by investors for bad performance, won’t this encourage very short term thinking?
You might be pleased to know that this has been an intense area of academic research. Afterall, reporting is expensive and companies would love to reduce the burden it imposes. And if reducing the frequency of reports actually improves company performance while also lowering costs, then this seems like a great thing to do!
The bad news is that the research is inconclusive.
Increased disclosure does change behaviour for company management (bold emphasis mine):
Actions to increase the amount of hard information in prices, such as disclosure, raise the total amount of information in prices and thus financial efficiency. However, they also distort the relative amount of hard versus soft information, and thus encourage the manager to take decisions – such as cutting investment – that improve hard information at the expense of soft.
The Real Costs of Financial Efficiency When Some Information Is Soft (Alex Edmans, Mirko S. Heinle, Chong Huang, 2016)
However, reduced reporting leads to information loss for investors, who now have to rely on less official sources of information which leads to investors making worse decisions:
Further tests suggest that the temporary harm to investors’ information sets arising from low-reporting frequency stocks (LRF) leads to elevated stock price volatility. Collectively, our results suggest that investors are unable to successfully offset the information loss arising from low reporting frequency, thus impairing their ability to value firms and adversely affecting the quality of financial markets.
The Dark Side of Low Financial Reporting Frequency: Investors’ Reliance on Alternative Sources of Earnings News and Excessive Information Spillovers (Salman Arif, Emmanuel T. De George, 2019)
We can also look at what happens in real life as a reference. The European Commission issued Directive 2013/50/EU in 2013, which abolished legally mandated quarterly reports for companies. The idea was that there would be efficiency gains by reducing the administrative burden on companies from needing to report every quarter.
Without the legal need to create quarterly reports, what happened was that… many of the largest companies went back to quarterly reporting anyway.7And indeed you can quickly Google and find quarterly reports from a wide range of European companies such as HSBC, Deutsche Bank, BMW, Airbus, Merck, Novartis, and AstraZeneca.
These companies didn’t create quarterly reports because they were legally required to. They did it because their shareholders wanted it.
Because even though investors know and worry about management being too short-term orientated and that reporting comes with extra costs… they’re more worried about whether management is hiding bad news or underperforming.
The reason this is such a problem is fundamentally an issue of asymmetry of information and trust.
The information asymmetry between management (who directly controls a company’s information) versus shareholders (who have zero direct access to information) due to the separation of ownership and control means that investors want more information to be reassured about company performance.
The problem of trust arises from asymmetric information because humans lie. Since shareholders are completely reliant on company management for information, they want to make sure they are not being lied to by management.
Especially in a volatile geopolitical world, investors want clarity that company management has realistic plans and can deliver results. Here’s a short extract from Apple’s recent8Can you tell how long it has taken me to edit and write this? Q2 2025 earnings call to give an example of what I mean (bold emphasis mine):
Ben Reitzes: All right, Tim. And then just with regard to China down 2%, I mean, you intuitively would have thought there would have been an increased nationalism there and perhaps it would have been worse than that. And the trajectory there improving even with subsidies because subsidies benefited your competitors, too. Just wondering if I could get a little more color there. Can it keep improving? What are you thinking with regard to that trajectory in China, given all the geopolitical tensions? Thanks.
Tim Cook: Yes, we were down 2%, as you point out, for the March quarter. And to provide a little more transparency around that, we were roughly flat when you remove the headwinds from foreign exchange. And so we did see quite a bit of sequential improvement from the December quarter, which was down 11. And again, for going out of the way for transparency, the channel inventory at the end of March, the unit channel inventory was similar to where we started the quarter. So there wasn’t a build of channel inventory in there. I do believe that the subsidies played a favorable impact on the results. It’s difficult to estimate with precision as to exactly how much, but I think it was positive. Some of our products are included. Some of them are not. Generally, on iPhone, if something is priced above RMB6,000, it is not eligible for the subsidy and the other products have different rules. But I do think it helped. And I think it’s helping others as well, I’m sure. iPhone was the key driver of the improvement sequentially. And so hopefully, that provides you some color. The other thing I would say is that the Mac, the iPad, and the Watch are attracting a majority of customers new to that product. And so that continues to look quite good in China. And iPhone was the top two models in urban China, and iPad was the top two tablets in urban China. So there’s some positive nuggets there.
You can see how investors worry and want to understand the business in more detail. “Hey, how is your China market doing and will geopolitical tensions affect your results? What does the long-term trajectory of your business look like?”
And you can see how management is willing to provide key information that might not be readily available. “Yes, we think the Chinese market is stable because we see the majority of our customers willing to buy our other products. And we continue to hold top 2 position in key product categories. Things are stable and you should not expect major fluctuations ahead.”
Now you might reasonably ask: “I understand that some companies aren’t trustworthy so they’re forced to give frequent updates. But why can’t companies that have a good track record stop doing quarterly reporting?”
The main answer to this is that there’s always something going on which will lead to investors wanting to know more. In the above example, you can see discussion of recent geopolitical tensions and subsidies being discussed. These sorts of developments happen all the time.
What investors want to know is: “Do you have a plan to deal with recent changes? Can I continue to trust you?”
You can also never quite be sure that a company’s management might make a mistake and suddenly want to cover it up. Just because you think they haven’t lied to you so far doesn’t mean they might not lie in the future.
This is why reporting is a constant activity. A company’s management might have trust today, but they need to keep working to maintain that trust. Trust is not a “one and done” type of thing.9This is true of all relationships in life. Not just the corporate relationship between investor and company.
A criticism I have seen online is that public companies are pushed to do quarterly reporting due to stock market rules. So when a company goes public, it means the company is about to shift into short-term mode because now they have those evil people called “shareholders” running the show.
This misunderstands how private companies work. Do you think just because you’re not listed on the stock exchange, you don’t have shareholders? And that your shareholders suddenly don’t care about being updated?
The primary difference between private and public companies are:
- Who you are reporting to; and
- What regulations and formats you have to follow when reporting results.
In fact, I have seen private companies that report their results even more frequently than every quarter. Sometimes even weekly!
Because it turns out that if you investors want information because they are worried and don’t trust you, they will ask for it. And now you don’t have the excuse of: “But it takes a long time and a lot of cost to comply with public company regulations.”
Being a private vs public company doesn’t make fundamental problems like the separation of ownership and control go away. That means it won’t make all the costs associated with solving the problem of the separation of ownership and control go away either. 10There is a separate argument here that the advent of mark-to-market accounting for institutional investors and desire for low volatility encourages publicly listed firms to take short-term actions to smooth volatility. I have also seen convincing arguments that private companies are more able to take risks because the lack of mark-to-market valuation means a lower need for price volatility management from the company. 11This is beyond the scope of what I want to cover here but it is an interesting question as to whether public ownership leads to lower innovation. However, the core question in this essay is about quarterly reporting. And even for risk taking private companies, quarterly reports don’t go away. So regardless of the outcome, quarterly reporting and measurement of profit is not at fault here.
At its core, quarterly reporting is about the fundamental human sin of lying and the trust problems that liars create in society.
3f. Myth 4: We should just abolish quarterly profit reporting because it encourages short-term behaviour
This is an interesting argument that essentially says “From a cost-benefit, having shareholder monitoring creates so much cost and downside to society due to short-term behaviour that we should just get rid of it.”
But woe be those who try to get rid of something they do not understand.
Just as the cryptobros rediscovered why we have financial regulation and had to reinvent it, so too will anyone who wishes to replace modern capitalism quickly learn to reinvent… modern capitalism rules.
What happens if we just get rid of the monitoring and reporting? The answer is fraud. It’s so much fraud.
Remember, the fundamental problem with the modern corporate structure is that the owners of a company and the management of the company are not the same people.
This asymmetric arrangement means that a company’s management is in an incredibly unique position to abuse their power. After all, they control what information is released to the public. They control all of the company system such as access to the company bank account. They authorize how money is spent and invested.
History is littered with examples of fraud and company waste where company management abused their position to enrich themselves at the expense of shareholders.
This isn’t just limited to major frauds such as Enron, Parmalat, Satyam Computer Services, or Kruger & Toll that collapses companies. It can also be things like executives using the company resources to take private jet flights, conduct home renovations, fund family vacations, etc. 12Companies are also loathe to disclose the full details of these arrangements for obvious reasons. Just see this SEC action against GE for the retirement benefits that were given to Jack Welch!
Some people might not care that “shareholders” get hurt on the basis that this sort of thing “hurts the bad people so who cares”.13I also have qualms about this sort of mentality where rules don’t matter so long as they hurt the people you don’t like. But this is a topic for another day. But remember, the average shareholder is not some random billionaire you personally dislike. The average shareholder is an average member of the public who just wants to save for retirement. This is who gets hurt when companies commit fraud.
People want to be able to invest their money. That means creating functioning equity markets where people can freely invest their money in stocks. This means creating protections. And those protections include information disclosure to shareholders and the pressure it creates on companies to act accordingly.
3g. Myth 5: Investors are fundamentally greedy and short-term focused
This is an argument I sometimes see online. It works a bit differently from all of the others.
The idea is that it doesn’t matter if we have ways of looking at a company’s performance long term, or that a lot of the current features in capitalism are here because they solve real problems. Nor does it matter who a shareholder is.
Fundamentally, investors are greedy and short-term focused. And it leads to an obsessive focus on quarterly short-term profit that makes everything worse. So we need to do something about capitalism or even get rid of it.
This is an interesting argument. But also… I don’t see it working.
Because the core issue here is that humans are greedy. Capitalism is just the vehicle through which that is expressed. If you get rid of capitalism… you haven’t solved the problem called the literal Biblical sin of Greed.
In non-profit organizations such as academia, you still get fights over budgets and performance targets. We have charities that go around trying to grow for the sake of growth and build empires even though as a non-profit organization they literally have no profit to chase. And in schools where children don’t even participate in structured organizations or manage money, they fight over things like who has the most candy.
One of the core ideas I want to communicate in this series of essays is that the problem with modern capitalism isn’t capitalism itself. There are three core problems:
- Human wants are unlimited, but resources are not. So we need some type of system to allocate resource;
- All large scale systems require legibility and standardization in order to solve practical problems that arise when operating large scale systems;
- Any attempt at legibility and standardization removes nuance.
It’s the removal of nuance and enforcing standardization that leads to many of the issues people complain about.
But simply getting rid of capitalism doesn’t mean you will end up with a better world. If all large scale systems eventually remove nuance and thereby create misery, then any replacement will just brutalize you in a different way. But now you also need to solve all the problems that capitalism was good at solving all over again.
So if people make the philosophical argument that capitalism is bad because fundamental humans are greedy, then the problem isn’t capitalism.
The problem is fundamentally humans.
In which case, that’s making my argument for me. Capitalism isn’t the problem. It’s just the vehicle through which the problems manifest.
But any other system will lead to bad outcomes too. Because the core reason we need large scale systems in the first place is humans.
It’s honestly a bit depressing once you realize that creating an economic system that doesn’t make you miserable is maybe impossible.
4. Conclusion
This has been a rather long post that goes in many directions. We started with a simple problem of: “Hey, how can we let people sell fractional ownership in companies?” and ended up with “And now we require quarterly financial reporting because we live in a globalized economy.”
But that’s not the key takeaway this time.
The key takeaway is that we are forced to invent esoteric and complicated systems because we have to solve the problem called “humans”.
As human society evolves, we need to create systems that facilitate human wants and needs. And these systems by necessity shape our society.
Once upon a time, some humans wanted to buy and sell company stock. Because humans fundamentally cannot trust each other without rules and processes to validate and enforce trust, we created a sprawling set of rules and regulations. And now we have a system that demands companies report their financials every quarter and obsesses over financial metrics.
This will not be the only time we will face this problem on this journey about modern capitalism. And we’re going to see how the need for large systems and solving the problem called “humans” will repeatedly drive how modern capitalism was shaped.
Capitalism is working as intended because it solves very real problems we need to be solved.
This time we tackled some myths about quarterly profit. But there are still major questions around capitalism that this did not resolve such as:
- What are the reasons we keep modern global capitalism? Why do people who aren’t rich billionaires say that modern capitalism is actually a good thing? Are they just paid shills?
- If companies are supposed to be efficient and their shareholders do care about the long-term results, why do companies still make incredibly stupid decisions?
- If capitalism is supposed to address the fundamental problem of resource allocation in an economy, why are things so unequal?
These are the questions we’ll start to work through over the coming essays.
For one of my New Years Resolutions, I plan to not write essays of ten thousand words or more and edit things faster. Looking at my drafts folder though… I might already be on track to break this very quickly.
Happy 2026. I hope you all stay safe and healthy.
- 1For reference, the World Bank also says all stocks globally are about $114 trillion. So retirement investing for only US individuals is 30% of everything in the world.
- 2The word comparative is doing a lot of heavy lifting here, as any accountant will tell you. Next time you meet one, ask them for their favourite story about IFRS 13. And at least have the decency to buy them a stiff drink while you’re at it.
- 3I will probably write an essay at some point about how metrics are selected, how to create good metrics, and how metric selection and measurement goes wrong. So while I could go in-depth about metrics and how it can distort behaviours / incentives, I will refrain from doing so here.
- 4So companies like Fidelity, Vanguard, etc. that I mentioned earlier.
- 5The World Federation of Exchanges claimed over 58,000 in 2022. So it’s likely even higher today.
- 6For example, Activision Blizzard prior to the Microsoft takeover would meet with investors at Blizzcon since company management were all in one place. These meetings also happen at large industry conventions or events for the same reason of convenience.
- 7And indeed you can quickly Google and find quarterly reports from a wide range of European companies such as HSBC, Deutsche Bank, BMW, Airbus, Merck, Novartis, and AstraZeneca.
- 8Can you tell how long it has taken me to edit and write this?
- 9This is true of all relationships in life. Not just the corporate relationship between investor and company.
- 10There is a separate argument here that the advent of mark-to-market accounting for institutional investors and desire for low volatility encourages publicly listed firms to take short-term actions to smooth volatility. I have also seen convincing arguments that private companies are more able to take risks because the lack of mark-to-market valuation means a lower need for price volatility management from the company.
- 11This is beyond the scope of what I want to cover here but it is an interesting question as to whether public ownership leads to lower innovation. However, the core question in this essay is about quarterly reporting. And even for risk taking private companies, quarterly reports don’t go away. So regardless of the outcome, quarterly reporting and measurement of profit is not at fault here.
- 12Companies are also loathe to disclose the full details of these arrangements for obvious reasons. Just see this SEC action against GE for the retirement benefits that were given to Jack Welch!
- 13I also have qualms about this sort of mentality where rules don’t matter so long as they hurt the people you don’t like. But this is a topic for another day.
- 1For reference, the World Bank also says all stocks globally are about $114 trillion. So retirement investing for only US individuals is 30% of everything in the world.
- 2The word comparative is doing a lot of heavy lifting here, as any accountant will tell you. Next time you meet one, ask them for their favourite story about IFRS 13. And at least have the decency to buy them a stiff drink while you’re at it.
- 3I will probably write an essay at some point about how metrics are selected, how to create good metrics, and how metric selection and measurement goes wrong. So while I could go in-depth about metrics and how it can distort behaviours / incentives, I will refrain from doing so here.
- 4So companies like Fidelity, Vanguard, etc. that I mentioned earlier.
- 5The World Federation of Exchanges claimed over 58,000 in 2022. So it’s likely even higher today.
- 6For example, Activision Blizzard prior to the Microsoft takeover would meet with investors at Blizzcon since company management were all in one place. These meetings also happen at large industry conventions or events for the same reason of convenience.
- 7And indeed you can quickly Google and find quarterly reports from a wide range of European companies such as HSBC, Deutsche Bank, BMW, Airbus, Merck, Novartis, and AstraZeneca.
- 8Can you tell how long it has taken me to edit and write this?
- 9This is true of all relationships in life. Not just the corporate relationship between investor and company.
- 10There is a separate argument here that the advent of mark-to-market accounting for institutional investors and desire for low volatility encourages publicly listed firms to take short-term actions to smooth volatility. I have also seen convincing arguments that private companies are more able to take risks because the lack of mark-to-market valuation means a lower need for price volatility management from the company.
- 11This is beyond the scope of what I want to cover here but it is an interesting question as to whether public ownership leads to lower innovation. However, the core question in this essay is about quarterly reporting. And even for risk taking private companies, quarterly reports don’t go away. So regardless of the outcome, quarterly reporting and measurement of profit is not at fault here.
- 12Companies are also loathe to disclose the full details of these arrangements for obvious reasons. Just see this SEC action against GE for the retirement benefits that were given to Jack Welch!
- 13I also have qualms about this sort of mentality where rules don’t matter so long as they hurt the people you don’t like. But this is a topic for another day.
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