non-GAAP Earnings Disclosures Research Articles

Economic Policy Uncertainty and Firms’ Non-GAAP Reporting

Using the US economic policy uncertainty (EPU) index developed by Baker, S. R., Bloom, N., & Davis, S. J. [2016. Measuring economic policy uncertainty. The Quarterly Journal of Economics, 131(4), 1593–1636. https://doi.org/10.1093/qje/qjw024], we examine the impact of policy uncertainty on firms’ non-GAAP reporting practices. We show that EPU increases both the likelihood and quality of non-GAAP earnings disclosures. These effects are more pronounced for firms with higher index ownership and for those with less informative GAAP earnings. Furthermore, we show that non-GAAP disclosures provide tangible economic benefit during periods of increasing EPU, including compensating for the reduced informativeness of GAAP earnings and reducing information asymmetry. Overall, our evidence suggests that non-GAAP reporting is a means by which managers communicate value-relevant information about their firms’ performance to investors during periods of high EPU.

Accounting Reporting Complexity and Non-GAAP Earnings Disclosure

ABSTRACT We examine whether the complexity of mandatory accounting disclosures prompts managers to voluntarily disclose adjusted measures of actual earnings performance, and whether this practice reflects attempts to obfuscate or mitigate the informational opacity accounting complexity creates for investors. Using the metadata in XBRL filings, we construct measures of accounting complexity that map directly to the mandated standards applied in financial statement filings. We find a positive and economically significant association between accounting complexity and managers’ propensity to disclose non-GAAP earnings information. This relation is robust and incremental to common measures of business and linguistic complexity, and the transitory nature of firms’ economic activities. We also find that the quality and informativeness of adjusted earnings information increases with accounting complexity, consistent with motives to better inform investors when accounting disclosures are complex. Overall, our results suggest that managers use non-GAAP earnings disclosure to mitigate the adverse informational effects of accounting complexity. Data Availability: All data are available from sources identified in the paper. JEL Classifications: M41; M43.

Conditional conservatism in GAAP earnings and the implications for the disclosure of non-GAAP earnings

We examine whether and how the degree of conditional conservatism in GAAP earnings influences managers' decisions to disclose non-GAAP earnings. Conditional conservatism imposes a downward bias and may negatively affect the information content of GAAP earnings. However, prior research documents that non-GAAP earnings exhibit higher persistence, predictive ability, and information content than GAAP earnings. Consequently, we argue that companies may disclose non-GAAP earnings to circumvent the constraints imposed by conditional conservatism. Our evidence is consistent with the existence of a positive association between the degree of conditional conservatism in GAAP earnings and the decision by firms to disclose non-GAAP earnings. We also document a positive association between the extent of conditional conservatism in GAAP earnings and both the magnitude of non-GAAP exclusions and frequency of non-GAAP disclosures.

Happy 20-year anniversary non-GAAP earnings: a systematic review of the literature

PurposeIt has been two decades since the first academic paper shone a spotlight on non-GAAP earnings. The past 20 years of research investigates concerns over the misuse of these disclosures and resulted in some significant changes to accounting and reporting standards across the globe. This paper aims to document the history of non-GAAP reporting and outline the emerging themes of the now matured practice of non-GAAP reporting.Design/methodology/approachThis systematic literature review searches two popular databases to identify the academic publications relating to non-GAAP reporting between 2002 and 2022. The paper uses bibliographic mapping to present the key statistics of the non-GAAP reporting field of research.FindingsThe non-GAAP reporting environment started out as the “wild West’ but, through regulation and public awareness, emerged as an important supplement to the traditional outputs of financial reporting. Current consensus is recent non-GAAP earnings are informative to users but there is lack of research into qualitative non-GAAP disclosures and the vast body of archival research needs triangulating with more experimental studies.Originality/valueThis paper contributes to the literature by documenting the past 20 years of non-GAAP reporting and identifying the important existing and emerging research areas concerning non-GAAP earnings disclosures.

Do High-Quality Auditors Improve Non-GAAP Reporting?

ABSTRACTPrior research finds that clients of high-quality auditors report higher-quality GAAP earnings. We extend this research to investigate whether auditor quality is associated with the quality of voluntarily disclosed non-GAAP earnings measures. Using a sample of Australian firms disclosing annual non-GAAP metrics, we find that clients of high-quality auditors are more likely to voluntarily disclose non-GAAP earnings numbers. However, clients of high-quality auditors make adjustments in calculating non-GAAP earnings (non-GAAP exclusions) that are less predictive of future earnings and less value relevant than those of other firms. These results indicate that their adjustments are of higher quality. We also find similar results for U.S. firms using a sample of quarterly non-GAAP earnings disclosures. Overall, our evidence indicates that commonly used indicators of audit quality for GAAP reporting are positively associated with the quality of voluntarily disclosed non-GAAP earnings measures.JEL Classifications: J33; M41.

The Effect of Investor Inattention on non-GAAP Disclosure

We examine whether investor inattention influences managers’ non-GAAP earnings disclosures. Hirshleifer and Teoh’s (2003) theoretical model predicts that managers are more likely to disclose upwardly-biased non-GAAP metrics when investors are inattentive. Employing a measure that captures exogenous variation in institutional investor inattention, we find that managers are more likely to provide non-GAAP disclosures, particularly those where non-GAAP earnings are greater than GAAP earnings, when inattention is high. Moreover, inattention is positively associated with the magnitude of non-GAAP exclusions, which suggests managers present better non-GAAP performance to inattentive investors. Consistent with managers exploiting investors’ limited attention, we find that stock prices respond more strongly to non-GAAP exclusions when investors are inattentive and that managers are more likely to respond to inattention with income increasing non-GAAP disclosures if they sell shares following the disclosure. Taken together, these findings suggest that managers respond opportunistically to inattentive institutions by disclosing aggressive non-GAAP earnings metrics.

Religion and disclosure of non-GAAP earnings

PurposeThe purpose of this study is to examine whether non-generally accepted accounting principles (GAAP) earnings disclosed by firms headquartered in high religious areas (religious firms) are more informative. The non-GAAP disclosure is voluntary and not subject to external audits, and it is difficult to verify the accuracy ex post, which provides management with incentives to strategically use non-GAAP reporting. This study examines religiosity as a potential governance mechanism that reduces management opportunism.Design/methodology/approachUsing a comprehensive sample from 2010 to 2018, the authors conduct univariate analyses and regression tests. Religiosity is measured by the number of religious adherents in the Metropolitan Statistical Areas of a firm’s headquarter location.FindingsThis study finds that religious firms disclose non-GAAP earnings more frequently compared to non-religious firms. This study further documents that religiosity is negatively associated with aggressive non-GAAP reporting. It also finds that items excluded by religious firms in calculating non-GAAP earnings are less associated with future performance, suggesting that these excluded items are transient and, thus, of higher quality. Finally, the market returns on unexpected non-GAAP earnings (i.e. earnings response coefficients) are greater for religious firms. Overall, the results of this study show that non-GAAP reporting by religious firms is more likely to be informative rather than opportunistic.Research limitations/implicationsDespite the authors’ best endeavors, this study does not fully address the issue of endogeneity, and therefore, the results of this study must be interpreted as strong association rather than causation.Practical implicationsReligious social norms (regional level) can complement a firm’s corporate governance and ethical codes (firm level) by attenuating undesirable, opportunistic management practices. These findings should be informative to investors who assess the quality non-GAAP disclosures. The findings of this study are also relevant to regulators [e.g. the Securities and Exchange Commission (SEC)] when they allocate limited resources. The SEC may use less resources for monitoring firms headquartered in religious areas and apply the saved resources on monitoring riskier firms.Originality/valueTo the best of the authors’ knowledge, this is the first study to show that religiosity may act as a potential monitoring mechanism that attenuates aggressive non-GAAP earnings and enhances the informativeness of non-GAAP. The findings of this study suggest that religious social norms (regional level) can complement a firm’s corporate governance and ethical codes (firm level) by restricting undesirable, opportunistic management practices.

CEO educational backgrounds and non-GAAP earnings disclosures

Non-GAAP earnings have received attention recently. Existing literature suggests CEOs’ educational backgrounds affect the financial reporting quality. Thus, the paper analyzes whether the educational background of CEOs affects the disclosure of non-GAAP earnings. Using logit regression to examine the probability of non-GAAP earnings disclosures, this study finds the coefficient value of MBA is 0.4171, which suggests that CEOs with an MBA degree are more likely to disclose non-GAAP earnings than other CEOs. In addition, the moderating effect of audit committee quality on the association between CEO educational backgrounds and non-GAAP earnings disclosures is investigated. The coefficient value of MBA×ACC_QUA is –2.809, which suggests that audit committee quality negatively moderates a positive association between MBA-holding CEOs and non-GAAP earnings disclosures. By focusing on a company’s non-GAAP earnings, this study contributes to the financial reporting literature. The results provide evidence that CEO education backgrounds and audit committee quality influence firms’ non-GAAP earnings disclosures. AcknowledgmentThe author acknowledges the financial support of the National Science and Technology Council, R.O.C. (Award number MOST 111-2410-H-035-048-).

Corporate social responsibility and non-GAAP reporting

ABSTRACT This study examines the relationship between a firm’s corporate social responsibility (CSR) performance and non-GAAP earnings disclosure. I find that firms with good CSR performance (i.e. CSR firms) are more likely to disclose non-GAAP earnings than firms with poor CSR performance (i.e. non-CSR firms). More importantly, I find that CSR firms provide more informative non-GAAP earnings than non-CSR firms. Furthermore, CSR firms’ decisions to disclose non-GAAP earnings are less affected by the incentives to meet earnings benchmarks or constraints on other earnings management tools. These findings are consistent with the notion that CSR firms communicate with stakeholders about their sustainable earnings through non-GAAP reporting.

CEO Social Capital and Non-GAAP Earnings Disclosure

CEO Social Capital and Non-GAAP Earnings Disclosure

Role of stock price informativeness in shaping non-GAAP earnings disclosures

ABSTRACT Using 107,411 firm-quarter observations from 2004 to 2017, we find that managers are less likely to report non-GAAP earnings with the increase of stock price informativeness, suggesting that information from stock prices discourages non-GAAP reporting from firm managers. We further show that stock price informativeness influences managerial incentive of non-GAAP reporting through two channels: (a) direct monitoring and (b) the improvement in the information environment. Accordingly, we find that the constraining effect is more pronounced when a firm’s monitoring mechanisms are weak and when the pre-disclosure information environments are poor. In addition, we find that the quality of non-GAAP earnings improves with the increase of stock price informativeness. Collectively, our results are consistent with the notion that information from the secondary stock price plays an important role in guiding managerial non-GAAP earnings disclosures.

The relation between non-GAAP earnings and accounting restatements: Evidence after regulation G

Scholarly findings on whether disclosure of Non-GAAP earnings is informative or opportunistic are inconsistent. Since the 2003 implementation of Regulation G, investors can view management's process of adjusting from GAAP earnings to Non-GAAP earnings. This study investigates the information content of Non-GAAP earnings in the context of restatements. The hypotheses of this study are based on the following two propositions. First, the informativeness of Non-GAAP earnings is determined by the nature of items excluded from GAAP earnings to derive Non-GAAP earnings (either nonrecurring special items or recurring exclusions). Second, restatements can be used to distinguish between informative and opportunistic Non-GAAP earnings disclosures. My results show that firms with restatements, especially fraud or core earnings restatements, exhibit greater relative use of Non-GAAP earnings disclosures that adjust GAAP earnings for positive other exclusions (recurring expenses). By contrast, disclosures of Non-GAAP earnings derived by excluding nonrecurring expenses (special items) from GAAP earnings are not associated with restatements.

Local political corruption and Firm's non-GAAP reporting

We examine whether local political corruption affects managers' discretionary disclosures of non-GAAP earnings. Using United States Department of Justice data on the number of corruption convictions of government officials, we find that firms headquartered in more corrupt districts (1) are less likely to report non-GAAP earnings, (2) have less aggressive non-GAAP earnings disclosures, and (3) experience a significant decline in the exclusion magnitudes of non-GAAP earnings. These results are more pronounced for firms with concentrated operations in their headquarter states and are robust to controlling for demographic characteristics, employing alternative corruption and non-GAAP measures, using the instrumental variable approach, and conducting a difference-in-difference analysis based on firms' relocation. Finally, we show that as local political corruption increases, managers exclude lower levels of both recurring and non-recurring items when calculating non-GAAP earnings. Overall, the results suggest that managing non-GAAP reporting is one channel through which firms could deter rent-seeking by corrupt officials.

Non-GAAP earnings quality in firms with data breach incident

PurposeAfter the massive data breach incident in 2017, Equifax voluntarily disclosed non-GAAP earnings that beat earnings targets by eliminating breach-related charges and used non-GAAP metrics to determine its executives' compensations. However, it is unclear whether its non-GAAP earnings exclusions and the use of non-GAAP earnings in compensation plans are justified. The purpose of this study is to examine non-GAAP earnings quality in firms with data breach incidents.Design/methodology/approachThe authors identified data breach firms from incidents reported in Privacy Rights Clearinghouse (privacyrights.org) during the period 2004–2017. The authors separate the victim firms into six groups based on financial status and non-GAAP earnings disclosure. Quarterly manager non-GAAP earnings per share data is retrieved from the database created by Bentley et al. (2018). Ordinary linear regression models are used in this study to test the authors’ hypothesis.FindingsThe authors find that, in general, the informativeness of non-GAAP earnings is higher than that of GAAP earnings in data breach firms. However, non-GAAP earnings quality vary in data breach firms with different financial health status. The quality of non-GAAP earnings in loss firms with data breach is higher than those in profit firms. Loss converters (i.e. data breach firms with negative GAAP earnings but positive non-GAAP earnings) disclose low quality non-GAAP earnings, which is different from the findings in prior studies.Practical implicationsThe findings are particularly useful to analysts who want to make accurate earnings forecasts of data breach firms by incorporating managers' non-GAAP earnings disclosures.Originality/valueThe authors are among the first to comprehensively analyze the quality of non-GAAP earnings in firms with data breaches. The findings in this study address the analysts' concern that data breach firms use non-GAAP earnings metrics to determine executives' compensation after the massive data breach incidents. Next, the authors provide evidence that the financial status of data breach firms affects the quality of non-GAAP earnings.

Non-GAAP Disclosures and Investor Uncertainty

We examine the association between I/B/E/S's disclosure of non-GAAP earnings and investor uncertainty around earnings announcements. On one hand, investor uncertainty may decrease with I/B/E/S's non-GAAP disclosure because these disclosures make investors aware of alternative performance measures for firm valuation and reduce the acquisition costs related to them. On the other hand, investor uncertainty may increase with I/B/E/S's non-GAAP disclosure because the opacity in how I/B/E/S determines non-GAAP earnings imposes additional integration costs on investors. Consistent with the latter effect dominating, we find that investor uncertainty is increasing in the amount of I/B/E/S's non-GAAP adjustments. In contrast, managers' non-GAAP adjustments, which are accompanied with a reconciliation to GAAP earnings and are therefore relatively more transparent, are not associated with investor uncertainty around earnings announcements. These results expand our understanding of how different sources of non-GAAP information affect capital markets and highlight the nuanced role of information intermediaries in the non-GAAP disclosure environment.

The association between EBITDA reconciliation quality and opportunistic disclosure

Purpose: This paper investigated the potential opportunistic disclosure of ‘earnings before interest, tax, depreciation and amortisation’ (EBITDA) by analysing the association between the quality of EBITDA reconciliations and factors associated with opportunistic disclosure. Design: Ordinary least squares estimation was used to regress an EBITDA reconciliation score on factors associated with opportunistic disclosure for a sample of stock exchange news service reports of companies listed on the Johannesburg Stock Exchange (JSE) for the financial years 2014 through 2016. Findings: The results suggest that the management of JSE-listed companies signal the credibility of EBITDA as a performance measure by providing higher quality reconciliations, rather than using poor quality EBITDA reconciliations to mask potential opportunistic disclosure. Practical implications: The results suggest that JSE-listed companies use EBITDA disclosure for informational purposes, rather than for opportunistic purposes. Value: This paper contributes to a limited corpus of research on EBITDA as non-GAAP earnings measure. It provides support for the adequacy of the JSE’s disclosure requirements in facilitating high-quality financial reports. The results are timely as the JSE is contemplating whether to issue expanded disclosure requirements intended to limit the potential opportunistic use of non-GAAP earnings disclosure.

Credit Default Swaps and Non-GAAP Earnings Disclosure

We examine the effect of credit default swap (CDS) coverage on voluntary disclosure using firm provided non-GAAP earnings as a laboratory. For a large sample of U.S. firms, we find that for companies with CDS coverage, the persistence of non-GAAP exclusions is lower, implying higher disclosure quality. The effect manifests across a range of performance measures and measurement windows and is strongest among non-investment-grade firms, entities for which monitors are more likely to rely on public accounting reports. This improvement in quality comes as a counterpoint to a decrease in the frequency of non-GAAP disclosure among firms that experience CDS coverage initiation. Collectively, our findings suggest firms counteract the perceived negative externalities associated with CDS coverage with higher-quality voluntary disclosure.

Managerial sentiment and non-GAAP earnings disclosure: evidence from terrorist attacks

ABSTRACT We examine how managerial sentiment affects non-generally accepted accounting principles (non-GAAP) earnings disclosure. Following recent studies, we use terrorist attacks in the US to measure the exogenous shocks to managerial sentiment. We find that (1) firms located in the attacked metropolitan areas are less likely to report non-GAAP earnings; (2) there is a significant decline in non-GAAP exclusions for affected firms, indicating more conservative non-GAAP earnings disclosure; (3) the effect of pessimistic sentiment on non-GAAP earnings disclosure is more pronounced when terrorist-attack events are perceived as more salient, and when managers are less experienced. Our main findings are robust to a battery of robustness tests. Overall, results of this study suggest that shocks induced by exogenous negative events affect managerial sentiment and corporate disclosure practice.

Non-GAAP earnings disclosures around regulation G – The case of “implicit non-GAAP reporting”

We identify a phenomenon related to non-GAAP earnings disclosure and examine its prevalence around Regulation G (RegG). Specifically, we analyze to what extent firms only disclose adjustments to GAAP earnings instead of entire adjusted earnings figures thereby not providing the ideal non-GAAP to GAAP reconciliation promoted by RegG. We refer to this reporting behavior as “implicit non-GAAP reporting” and ask three different questions: How is “implicit non-GAAP reporting” related with the adoption of RegG? What type of firm reports implicit non-GAAP measures? What are the motives for “implicit non-GAAP reporting” post-RegG? Our analyses yield three key findings. First, the frequency of “implicit non-GAAP reporting” spikes after the regulatory intervention but to a lesser degree also existed before. Second, during the post-RegG time period, the prevalence of “implicit non-GAAP reporting” is much higher among firms who only started to report non-GAAP earnings after RegG was enacted (starters) than among those, which continued to disclose non-GAAP earnings across the regulatory intervention (continuers). Third, we show that only for starters, “implicit non-GAAP reporting” is associated with motives of beating analyst earnings forecasts as well as experiencing GAAP losses. Our study provides important insights for regulators, firms and academics into "implicit non-GAAP reporting" by examining properties and determinants of implicit vs. explicit non-GAAP earnings for different types of firms around RegG.

Non-GAAP Reporting and Debt Market Outcomes: Evidence from Regulation G

We exploit the introduction of Regulation G (RegG) by the U.S. Securities and Exchange Commission (SEC) in 2003 to study the association between non-GAAP earnings disclosure and debt market outcomes. Specifically, we focus on a subset of 199 S&P 500 firms to analyse the association between non-GAAP earnings disclosure and long-term issuer credit ratings as well as bond spreads before and after the regulatory intervention. We find that post-RegG, correlation between non-GAAP earnings disclosure and bond spreads changes from positive to negative but do not document any change in its correlation with respect to credit ratings. Our study provides first evidence that post-RegG, bond investors, but not rating agencies, seem to view non-GAAP earnings disclosure favourably as part of their credit risk assessment. In practical terms, our results document a specific benefit of RegG and may inform the SEC that its goal of more accurate security pricing extends to the bond markets, which is an under-researched area in the context of non-GAAP regulation.