Managers' Use of 'Pro Forma' Adjustments to Meet Strategic Earnings Benchmarks

Abstract

The practice of reporting manager-adjusted 'pro forma' earnings numbers in quarterly earnings press releases has attracted considerable attention in recent years. Prior research suggests that while some managers report these adjusted numbers to better reflect core earnings, others may use these earnings adjustments to meet strategic earnings benchmarks on a pro forma basis when they fall short based on GAAP reporting standards. The difficulty lies in distinguishing the 'good guys' from the 'bad guys.' Using hand-collected pro forma earnings data, we investigate the extent to which different types of earnings adjustments affect the spread between pro forma earnings and GAAP earnings from continuing operations. Moreover, we investigate which types of adjustments managers use to meet strategic earnings benchmarks. In addition to the exclusion of one-time items like restructuring charges, the results indicate that managers often exclude recurring expenses such as research and development, depreciation, and stock-based compensation to meet these strategic benchmarks. The exclusion of recurring items is especially indicative of manager opportunism in pro forma reporting.