Question

Consumer electronics giant JB Hi-Fi is sticking by its reasoning for releasing a profit downgrade buried deep within a presentation to analysts last week, rather than make a stand-alone statement to the stock exchange. This follows being hit with a “please explain” by the ASX (Australian Stock Exchange) in the wake of the earnings warning that sent its shares plummeting.

JB Hi-Fi yesterday issued its response to detailed questioning from the ASX and the presentation by chief executive Richard Murray at the Macquarie Australia Conference, where during a lengthy talk on the retailer he handed out a 3 per cent revision to its full-year net profit guidance.

The profit warning was contained on page 4 of a 14-page presentation to the conference, and when it was lodged with the ASX on the day it was titled Macquarie Australia Conference Presentation, with no reference to the profit warning.

Shares in JB Hi-Fi sank 10 per cent after the consumer electronics giant cut its profit forecast for fiscal 2018 at the conference, marking the stock’s biggest single-day fall since 2011. The ASX issued JB Hi-Fi with a series of questions over its communication of the downgrade to the market, pushing the retailer to explain why it wasn’t released as a stand-alone statement.

“The company’s revised net profit after tax guidance was a decrease of 3 per cent from the midpoint of the company’s previous NPAT guidance,’’ JB Hi-Fi said in its response to the ASX.

“JBH notes guidance in section 7.3 of Guidance Note 8 issued by the ASX which suggests that companies should treat an expected variation in earnings compared to its published guidance equal to or less than 5 per cent as not being material and presume that its guidance therefore does not need updating.

“JB Hi-Fi did not consider that the information contained in the fiscal year 2018 outlook slide would have a material effect on the price or value of the entity’s securities,” the statement said.

Bruce Smith, principal at Alphinity Investment Management, said he was “surprised” by the ASX’s query of JB Hi-Fi. “I’m surprised by it considering the announcement on earnings fell short of the ASX’s own definition of materiality,” he said. “While the share price move was a little greater than the downgrade, that was something that could not be known by the company in advance.”

1. Use Classical Political Economy Theory to explain JB Hi-Fi’s decision to release its profit downgrade in the way it did. Make sure you explain what Institutional Theory is, and support your observations with evidence from the case study. (references)

2.Use the Managerial branch of Stakeholder Theory to explain JB Hi-Fi’s reporting decisions. Make sure you support your observations with evidence from the case study. (references)

Answer 1

1.) Classical Political Economy Theory is what we commonly understand as Economics. It was a school of thought prevalent in the late 18th and early 19th century, main proponents being Adam Smith, Ricardo, Malthus and John Stuart Mill. Classical economists believed that markets should be laissez-faire i.e. firms should be self-regulating systems, governed by natural laws of demand and supply. Having said that, classical political economy theorists also understood that markets cannot be completely free - from legal, governmental regulations.

To understand JB Hi-Fi's decision to release its profit downgrade the way it did, from point of view of Classical Political Economy Theory, JB Hi-Fi must have had laissez-faire in mind. The company knew the profit downgrade will have an impact on its share prices on ASX (though it probably did not realise the material impact it will actually have!), but it trusted the market will adjust via the natural processes of demand and supply. The company's statement that, “JB Hi-Fi did not consider that the information contained in the fiscal year 2018 outlook slide would have a material effect on the price or value of the entity’s securities", supports our reasoning that JB Hi-Fi trusted market forces to adjust in their natural course, to the news of a marginal profit downgrade.

Institutional Theory proponents believe that institutional environment can strongly influence the development of formal structures in an organization, often more profoundly than market pressures. Institutional Theory emphasizes on rational myths, legitimacy and isomorphism.

To understand JB Hi-Fi's decision to release its profit decision from the point of view of the Institutional Theory, let us focus on the statement from the company, which says - “The company’s revised net profit after tax guidance was a decrease of 3 per cent from the midpoint of the company’s previous NPAT guidance,’’ JB Hi-Fi said in its response to the ASX. "JBH notes guidance in section 7.3 of Guidance Note 8 issued by the ASX which suggests that companies should treat an expected variation in earnings compared to its published guidance equal to or less than 5 per cent as not being material and presume that its guidance therefore does not need updating."

Also, the statement from Bruce Smith, principal of Aphinity Investment Management - "I’m surprised by it considering the announcement on earnings fell short of the ASX’s own definition of materiality?."

From the above 2 statements, we understand that JB Hi-Fi was trying to confirm to the idea of 'legitimacy', as propounded by the Institutional Theory, by adhering to the ASX's guidelines that an expected variation of 5% or less in published guidance is not material and guidance does not need updating.

2). Managerial Branch of Stakeholder Theory focuses on the idea that when corporate management will be likely to attend to the expectations of particular stakeholders, to the extent that stakeholder relationship needs to be managed in the interest of the organisation. Organisations, therefore, need to adapt operating and disclosure strategies. One of the methods of operating strategies is disclosure of the financial information both to the financial stakeholders and government regulators.

To understand JB Hi-Fi's decsion of announcing their profit downgrade the way it did, from the point of view of Managerial Branch of Stakeholder Theory, let us consider the company's response to ASX query - “JB Hi-Fi did not consider that the information contained in the fiscal year 2018 outlook slide would have a material effect on the price or value of the entity’s securities,” the statement said.

JB Hi-Fi had not only kept the ASX guideline in mind, per the Managerial branch of Stakeholder Theory, also considered the impact this profit downgrade might have on stakeholders, had it been released through a separate statement. The company did not want its stakeholders to give the profit downgrade more due importance than it deserved by releasing through a separate statement. In addition, JB Hi-Fi also kept in mind the ASX guidelines when releasing the information. Its management balanced expectations of both the important stakeholders - stock market and government.