Accounting Reporting Complexity and Non-GAAP Earnings Disclosure

Abstract

The continuing proliferation of non-GAAP (or adjusted) earnings measures in corporate disclosures has led accounting standard-setters and financial reporting regulators to debate whether this disclosure trend is in response to the increasing complexity of GAAP. We inform this debate by investigating the role of accounting-based complexity in shaping managers’ non-GAAP disclosure choices and the quality of non-GAAP earnings information. Using an XBRL-based measure of accounting reporting complexity that links directly to the FASB codification, we find that managers’ propensity to report a non-GAAP earnings metric increases with the degree of accounting complexity as reported in financial statement filings. Notably, the effect of accounting-based complexity on non-GAAP disclosure is robust to, and distinct from, the effects arising from operational complexity and the readability of the financial report. Our results also indicate that managers’ non-GAAP disclosure propensity is particularly sensitive to the reporting complexity of the firm’s income and cash flow statements as well as the complexity of specific accounting concepts appearing in the filings. Furthermore, we find that the earnings items managers exclude when deriving the non-GAAP earnings figure are of higher quality when accounting complexity is high. This result suggests that in the face of increasing accounting complexity, managers use non-GAAP adjustments as a tool to better communicate the firm’s financial performance. Taken together, our study is the first to provide empirical evidence that non-GAAP reporting is in-part a strategic response to the complexity of accounting principles.