When Mandatory Financial Forecasts Go, What Path Should Firms Take?

The Financial Supervisory Commission (Executive Yuan) decided on 12 August to end mandatory financial forecasts by publicly traded companies, effective 1 January 2005. In a thinly traded stock market like Taiwan’s, and without an adequate, complete set of supporting laws and regulations, the mandatory financial forecasting system’s drawbacks outnumbered its advantages.

The Financial Supervisory Commission (Executive Yuan) decided on 12 August to end mandatory financial forecasts by publicly traded companies, effective 1 January 2005. In a thinly traded stock market like Taiwan’s, and without an adequate, complete set of supporting laws and regulations, the mandatory financial forecasting system’s drawbacks outnumbered its advantages.

When mandatory financial forecasts are discarded, investors may fear that the lack of a basis for reference will lead to more arbitrage from the information asymmetries alluded to above, and price judgments by public companies and research institutions may be affected. Here, I will roughly sketch the main features of the USA’s financial forecast system, which may perhaps provide a useful reference for Taiwan when it gets down to drafting its own comprehensive set of measures.

As a first approximation, the predictive information in the US system can be broken down into three categories:

• Communication of financial forecasts must be in accordance with rules set by the American Institute of Certified Public Accountants (AICPA). Although the AICPA provides standards for CPAs carrying out preparation and examination of financial forecasts (similar to Taiwan’s current system), as well as agreement procedures, the Securities and Futures Commission has not required that forecasts be reviewed by CPAs
• Where a company undergoes a merger, split, significant disposal of assets, acquisition of managing interest in major real estate, or other important changes in connection with a corporate reorganization, it must include a pro forma statement disclosing the relevant information in its financial reports. However, the company may choose to use financial forecasts to substitute for pro forma profit and loss statement disclosure.
• For their quarterly financial statements, companies must issue a "Management's Discussion and Analysis of Financial Condition and Results of Operations" (MD&A) explaining its financial outlook information. Other than this, they must also include important matters known to management but not yet recorded in the financial statements, as well as information on expectations regarding uncertainties. Those that provide financial outlook information under safe harbor clause rules can avoid legal liability and do not need CPA certification.

• When companies make public CPA-reviewed or audited figures in quarterly financial reports, they can include forecast data for the following quarter. They can adopt an information evaluation approach to encourage information openness, and such information need not be subjected to CPA review.
• On the 15th of each month, companies should be required to make public their previous month’s monthly profit/loss and their cumulative profit/loss, and compare them with financial forecasts. If those figures differ from financial forecasts by a certain percentage or amount, a decision must be made whether or not to revise their forecasts, or else issue an explanation of why they no longer apply.
• In addition to strengthening disclosures of timely profit/loss information, it should also be necessary to make comparisons with CPA-certified financial statements on a quarterly basis. If discrepancies exceed prescribed standards, the reasons and attending facts must be stated publicly.
• For invested companies accounted for using the equity method, where investment income reaches a certain amount or percentage of pre-tax net profit, then the semiannual financial reports should be audited.
• For public companies whose production is located offshore, quarterly preparation of consolidated statements can keep financial statements from losing veracity, so such companies should be encouraged to issue consolidated financial statements.
• Annual financial statement filing periods can be shortened to prevent lengthy information gaps from possibly degrading information openness and timeliness.
• Companies that have yet to establish independent boards of directors/supervisors should be encouraged to open up their boards’ internal decision-making processes.

• When companies release information on future performance, extensive information disclosures should be required in every case in order to weed out violators eager to exaggerate their performance. Besides being able to perform follow-up checks that could prove if important information was untrue, one could also consider whether to put overall limits on external fundraising.
• When a company’s future development is discussed at investor conferences and press conferences, these should address estimated sales prices, sales numbers, orders, etc., and not its operations.
• The competent authority can require those companies that prefer to release profit information to submit quarterly financial forecasts.