Non-GAAP Reporting and Investor Attention: Are Investors Misled by Exclusions of Recurring Expenses from Non-GAAP Earnings before Restatement Announcements?

Abstract

Material financial restatements reveal GAAP-based misreporting and thus are a strong signal of low GAAP reporting quality. We explore these reporting shocks and investigate whether heightened investor scrutiny of GAAP reporting quality after material restatements has a spillover effect on investors’ perceptions of aggressive non-GAAP reporting choices. We find that investors reward aggressive non-GAAP reporting choices before material restatements (i.e., ERC premium) but penalize the same reporting choices after material restatements (i.e., ERC discount). Furthermore, we document that short- and long-term market reactions to material restatements are more negative for firms that aggressively reported non-GAAP earnings before the announcement of material restatements. We provide evidence that heightened investor scrutiny of GAAP reporting quality affects investors’ perceptions of aggressive non-GAAP reporting choices. Finally, our findings are consistent with the idea that aggressive non-GAAP reporting choices misled investors before material restatement announcements.