Google's plunge

Google went down more than 50 bucks, or about 12%, in after hours trading yesterday following an earnings disclosure. This was despite strong results, because Google missed its numbers – a big problem when you’re flying as high as Google is.

According to the WSJ, Google’s blaming this on a higher effective tax rate resulting from allocating more expenses to international operations and therefore shifting net to the US, where taxes are higher.

Well, it’s nice to see that Google apparently isn’t manipulating earnings to meet expectations. But did Google have material undisclosed information? Probably not. A company doesn’t have to disclose every bit of information every second. A big problem with such disclosures is that they may be more misleading than helpful, and that could get the company in trouble.

From a business standpoint, should Google have been more forthcoming with analysts that Google knew were wrong? That’s not Google’s business model. And it certainly makes sense for a company not to get to “entangled” with analysts’ estimates, thereby building a market expectation that Google will always correct mistakes and creating a risk of holding Google responsible for their mistakes.

There’s a middle ground: Google could have private conversations with the most expert and active analysts and tell them more about what’s going on, including the tax issue. But Google can’t do that because of Arthur Levitt’s pride and joy, Reg FD. Here’s some of what I’ve had to say on that.

All of this is to say that disclosure presents very complex issues, and they differ from firm to firm. One arguable goal of disclosure is to get information into the market so that you don’t get lurches like what happened yesterday, which increase risk and therefore the cost of capital. You can decide from the above whether the government’s myriad rigid rules on disclosure further this goal.

Update: The WSJ discusses the effect of Google's lack of analyst guidance on the price swings of its stock, and the costs and benefits of that practice.  It reports some institutional dissatisfaction, but notes that lack of guidance is a "growing trend."  Nothing about the possible regulatory causes of this trend.

Comments

[geoff manne]

Excellent comments. Reg FD, as you have pointed out, is a disaster, and I literally cringe when I hear or see Levitt's name (shudder). The other problem here is that disclosure of information set X sets up an expectation that all relevant information is contained in the set -- or else wouldn't the government require more disclosure? I don't know how large this effect would be, because I'm sure there are plenty of analysts/market watchers who are aware of the trap, but I suspect it can have some effect. It also surely has some effect at the other end, as you suggest: Firms organize their disclosures around complying with the rules rather than actually thinking about what information to disclose. At each end disclosure rules set up an expectation which becomes something of a self-fulfilling prophecy--sometimes to the detriment of the supply of information.

[Michael Guttentag]

We have a nice counterpoint in the Enron testimony on earnings guidance to what Google has done in choosing not to give analysts any earnings guidance. Google wants to avoid the slippery slope of starting to manage financial reporting and eventually operations to meet Wall Street expectations. Does this have anything to do with Reg FD? Only very indirectly. Before Reg FD, companies could provide subsidies to investment banks by providing them information that was not provided to the markets generally. Some, e.g. Choi and Talley, have argued these subsidies were a good thing.

Without the potential gain from this subsidy there is slightly less incentive to provide guidance, but the real story is that Google's management is not just keeping their focus on value creation in place now, but is also committing to avoid earnings management traps in the future. There is little evidence that this is a reaction to too much regulation.

Finally, volatility that reflects changes in estimates of the value of the firm is not inherently a bad thing.

[Larry E. Ribstein]

I suppose you could call it a "subsidy." As in, I "subsidize" the restaurant for serving me food. If I were prohibited from making a "bribe" of this sort, I would have to do without this service.

That might be better for me. I could then focus on lower calorie and less time-consuming ways to eat. So, also, this way of doing business might be good for Google apart from the regulation. Or it might not. The WSJ article suggests this lack of guidance is a trend -- it's not just companies that don't do evil. There's some evidence to support this.

I understand that price changes that reflect value changes are not bad -- they're a sign the market's working. But less information means sharper jumps, which investors would prefer less of, all else equal. This was one of Henry Manne's original arguments against insider trading regulation.

[Michael Guttentag]

Excellent points. What I call a subsidy, you call a payment. That is entirely fair. Though I would say as a former investment banker, I’m not quite sure that companies are getting their money’s worth. Remember in this context nothing prevents the firm from paying for that food directly.

It is also true that there are some benefits in using “private” disclosures to improve share price accuracy, but in the context of providing earnings guidance the end result may be less accurate, rather than more accurate share prices. A company that worries about the appearance of its earnings may be less willing to let the chips fall where they may, and let the stock rise and fall as the expected value of the firm changes.

[shoe stretchers]

If you were going to buy a golf club, you wouldn't walk into a store and buy the first one you see, would you? Of course not; especially if you want to improve your golf game! You'll want to hold the club, take some practice swings, hit some balls if the store has a practice spot, and look at the price, of course. If you are considering buying running shoes, you need to go through a similar process and take the time to find the perfect shoe.