Qualitative characteristics of non-GAAP disclosures and non-GAAP earnings quality

Abstract

We examine how the qualitative characteristics of a non-GAAP earnings disclosure reveal the quality of the non-GAAP performance metric itself. We measure the qualitative aspects of the non-GAAP disclosure using an index of 12 hand-coded characteristics and presentation choices that provide context to non-GAAP disclosures. We find that more transparent qualitative information in non-GAAP disclosures is associated with more transitory non-GAAP exclusions and a lower likelihood that managers will aggressively exclude expenses in calculating non-GAAP earnings to meet or beat analysts’ forecasts. We also find that the association between non-GAAP exclusions and earnings announcement period returns is less negative for firms with more transparent qualitative information accompanying their non-GAAP disclosures. Overall, these results suggest that qualitative characteristics of non-GAAP disclosures convey useful information about the quality of non-GAAP earnings metrics.