non-GAAP Earnings Research Articles

Do High-Quality Auditors Improve Non-GAAP Reporting?

ABSTRACT Prior 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.

China’s on lockdown and the U.S. is free to roam…The Properties of Non-GAAP Earnings in China

China’s on lockdown and the U.S. is free to roam…The Properties of Non-GAAP Earnings in China

The Informativeness of Non-GAAP Earnings: Empirical Evidence on China

The Informativeness of Non-GAAP Earnings: Empirical Evidence on China

The information content of alternative performance measures in the European context

The discretionary nature of alternative performance measures raises the question of their information content, particularly in the European Union where, unlike the United States, there is no specific regulation but only a recommendation without coercive power. Based on hand-collected data in press releases of French and UK firms, we show that non-GAAP earnings measures are more informative compared with GAAP counterparts. However, the alternative performance measures may be used opportunistically when firms fall short of certain accounting earnings benchmarks.

The risk-relevance of non-GAAP earnings

The risk-relevance of non-GAAP earnings

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.

Filling in the GAAPs in Individual Analysts’ Street Earnings Forecasts

Analysts’ street earnings forecasts are sometimes based on GAAP earnings and sometimes based on non-GAAP earnings, which exclude various GAAP earnings components. Therefore, differences in analysts’ street earnings forecasts may capture differences in not only expected performance but also the earnings metric forecasted. We argue that analysts who forecast non-GAAP, rather than GAAP, street earnings are more likely to separately analyze earnings components. Consistent with this argument, we find that analysts who forecast non-GAAP street earnings issue relatively more accurate forecasts. We also argue that excluded earnings components often reflect negative transitory items, and that variation across analysts in the earnings metric forecasted suggests that the negative excluded items are forecasted by only a subset of analysts. Consistent with this assertion, we find that variation across analysts in the earnings metric forecasted is associated with a lower consensus GAAP earnings surprise and lower stock returns around the earnings announcement. Finally, although variation in the earnings metric forecasted is a source of analyst forecast dispersion, we find that it is also incrementally associated with a lower earnings response coefficient, consistent with the existence of transitory items. We therefore find that the variation in the earnings metric forecasted is an important source of analyst forecast dispersion that predicts not only a lower earnings surprise but also a lower earnings response. This paper was accepted by Brian Bushee, accounting. Funding: Financial support from the Gatton College of Business & Economics, the KPMG Fellowship at the Mendoza College of Business, and the Goizueta Business School is gratefully acknowledged. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2022.4553 .

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-).

Taxes in Non-GAAP Reporting: Evidence of Strategic Behavior in Selecting Tax Rates Applied to Exclusions

When reporting after-tax non–generally accepted accounting principles (GAAP) earnings, firms are required to adjust for the tax effects of exclusions. Since 2010, the Securities and Exchange Commission (SEC) has issued and updated compliance and disclosure interpretations (C&DIs), which specifically require firms to disclose the tax effects of exclusions. We assemble a detailed, hand-collected data set of S&P 1500 firms’ disclosures to provide the first large-sample evidence on the reporting of the tax effects of non-GAAP exclusions. We find three key results. First, echoing the SEC’s concern, a significant proportion of non-GAAP reporting firms do not follow the C&DI guidelines (i.e., they do not disclose the tax effects of exclusions). Second, among firms that disclose the tax effects of exclusions, we find that managers strategically select the tax rates applied to exclusions to achieve after-tax earnings targets. Third, manager-reported non-GAAP earnings are less persistent for future operating earnings and cash flows relative to non-GAAP earnings calculated by applying various benchmark tax rates to exclusions. This evidence suggests that managers’ strategic behavior in selecting the tax rates applied to exclusions pollutes reported non-GAAP earnings and reduces their usefulness for predicting future performance. Overall, our results shed light on a specific channel through which firms use non-GAAP reporting to meet or beat earnings expectations. This paper was accepted by Brian Bushee, accounting. Funding: N. (X.) Chen appreciates financial support from the University of Houston. T. Shevlin acknowledges financial support from the Paul Merage School of Business at the University of California–Irvine. P.-C. Chiu acknowledges the financial support received from the Hong Kong Research Grant Council [Grant RGC14522716]. Supplemental Material: Data files and the online appendix are available at https://doi.org/10.1287/mnsc.2022.4433 .

Why Do Large Positive Non-GAAP Earnings Adjustments Predict Abnormally High CEO Pay?

ABSTRACTCEOs of S&P 500 firms that report high non-GAAP earnings relative to GAAP earnings receive substantial unexplained pay. Crucially, this result remains even after controlling for the level of non-GAAP and GAAP earnings. These firms are relatively poor performers (i.e., low GAAP earnings and stock returns) and have less powerful CEOs, consistent with non-GAAP earnings being used as justification when high executive pay is more likely to cause outrage. Additionally, despite the lower GAAP and return performance, these firms are more likely to beat the earnings targets specified in their compensation plans, which likely increases investors' perceptions of core operating earnings and reduces outrage. Indeed, these firms face less dissent from shareholders and proxy advisors, and no additional media scrutiny. Our evidence suggests that the fraction of CEO pay that seems attributable to opportunistic non-GAAP reporting, while limited, is economically meaningful.JEL Classifications: G14; G34; G38; M12; M41.

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.

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.

CEO Social Capital and Non-GAAP Earnings Disclosure

CEO Social Capital and Non-GAAP Earnings Disclosure

Auditor Monitoring of Non-GAAP Earnings

Auditor Monitoring of Non-GAAP Earnings

Non-GAAP earnings and stock price crash risk

We investigate whether non-GAAP earnings disclosures increase stock price crash risk. Consistent with non-GAAP disclosures allowing managers to inflate investors’ perceptions about firm performance, our results indicate that income increasing non-GAAP reporting increases crash risk. We also find that managers can use non-GAAP reporting as a substitute for earnings management to withhold bad news from investors (the traditional explanation for crashes). Finally, we find a positive association between non-GAAP reporting and the likelihood of subsequent events that can trigger a crash. Overall, our evidence is consistent with some non-GAAP disclosures exposing investors to risks of large and sudden price declines.

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.

When does forecasting GAAP earnings entail unreasonable effort?

SEC rules require managers to reconcile their non-GAAP earnings forecasts with the most directly comparable GAAP forecasts unless doing so would entail ‘unreasonable effort.’ A significant number of managers rely on the unreasonable efforts exception to justify the omission of comparable GAAP forecasts. We analyze firms that rely on the unreasonable efforts exception and find that their non-GAAP earnings forecasts are more likely to exclude significant recurring expenses that are not excluded by analysts. Our results suggest that almost a third of managers exploit the unreasonable efforts exception to exclude significant recurring expenses from their earnings guidance.

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.