Are Investors Misled by Non-GAAP Expense Exclusions Used to Beat Analysts’ Earnings Forecasts?

Abstract

We investigate whether investors are misled by firms that exclude particular expenses in calculating non-GAAP earnings in order to beat analysts’ earnings forecasts. Our empirical analyses suggest that firms that pursue a strategy of non-GAAP reporting to beat analysts’ earnings forecasts not only avoid the market penalty normally assessed to firms that miss expectations, they are rewarded by the market. However, when we examine the future performance of these firms we find that they subsequently perform similar to firms that miss expectations. Further, our persistence tests suggest that non-GAAP expense exclusions used to beat forecasts exhibit persistence that is indistinguishable from the persistence of non-GAAP earnings. Taken together, our evidence strongly suggests that at least some investors are misled by the use of non-GAAP expense exclusions.