Pro Forma Disclosures Research Articles

Randomized Study of Providing Evidence Context to Mitigate Physician Misinterpretation Arising From Off-Label Drug Promotion.

Recent court decisions have thrown into question the Food and Drug Administration's rules limiting manufacturer promotion of prescription drugs for unapproved uses. We assessed how providing pro forma disclosures or more descriptive evidence context about the data supporting an off-label claim affected physicians' beliefs about drug efficacy. In online and mailed surveys, we randomized national samples of board-certified, clinically active cardiologists, internists, and endocrinologists to receive 1 of 3 information scenarios about a hypothetical drug derived verbatim from excerpts on the website for Vascepa, a prescription fish oil for which Food and Drug Administration specially permitted off-label promotion after a manufacturer lawsuit. The scenarios presented information about the approved on-label indication (severe hypertriglyceridemia), off-label claim + pro forma disclaimers (suggestive but not conclusive evidence for use as an add-on to a statin for patients reaching low-density lipoprotein goal but with persistent moderate hypertriglyceridemia), and off-label claim + evidence context (eg, reports on 3 trials failing to demonstrate cardiovascular benefit of other triglyceride-lowering drugs for such patients). Among 686 respondents (48% response rate), 29% reported receiving off-label information about Vascepa (ie, use as an add-on to a statin) from the manufacturer, and 16% had prescribed it off-label for this purpose. Off-label prescribing was 5 times higher among physicians who received such off-label information (38% versus 7%, P<0.001). For the hypothetical drug, the proportion of physicians endorsing the unproven claim that the drug reduced cardiovascular risk was similar among those randomized to the on-label and off-label claim + pro forma disclaimers scenarios (35% versus 37% [95% CI, -6% to 11%]), but substantially lower among those randomized to the off-label claim + evidence context scenario (21% [95% CI, -24% to 7%]). Physicians who received company information about the unapproved use of Vascepa were more likely to report prescribing it off-label. Supplementing off-label claims with evidence context improved the prescribers' knowledge and reduced enthusiasm for the unproven, off-label indication of reducing cardiovascular risk.

Pro Forma Disclosure and Investor Sophistication: External Validation of Experimental Evidence Using Archival Data

Insights on how ordinary, less-sophisticated investors interpret and process management-issued pro forma earnings numbers are useful to regulators because of concerns that pro forma disclosures are misleading to ordinary investors. Two recent experimental studies (Frederickson and Miller, 2004 and Elliott, 2006) find that the existence of a pro forma number in the earnings press release as well as the relative placement of the pro forma and GAAP earnings figures within the press release affect the judgments of less-sophisticated investors but not those of more-sophisticated investors. Experimental and archival methodologies complement one another and results that persist in both settings are likely to be robust to both internal and external validity concerns. Therefore, we complement experimental evidence using trade-size-based proxies constructed from intraday transactions data to distinguish the trading activities of less-sophisticated investors from more-sophisticated investors. Our results suggest that less-sophisticated investors rely significantly more on quarterly earnings press releases that include a pro forma number than on those that do not, while more-sophisticated investors exhibit the opposite behavior. This result is consistent with Frederickson and Miller's experimental evidence. Further, consistent with Elliott's results, we find that less-sophisticated investors rely more on the pro forma figure when it is placed before the GAAP earnings number in the press release, while more-sophisticated investors' trading behavior is unaffected by the relative placement of the two earnings metrics. We conclude that the existence of a pro forma number as well as its strategic placement in the press release generally affect the judgments of less-sophisticated (but not more-sophisticated) investors and these inferences are robust because they persist in both experimental and archival settings.

Pro forma disclosure practices of firms applying IFRS

Purpose – The purpose of this paper is empirically investigate the pro forma disclosure behavior of US-listed foreign firms applying International Financial Reporting Standards (IFRS). Design/methodology/approach – The annual earnings press releases of US-listed foreign firms on the New York Stock Exchange are analyzed to compare the effect that reporting standard (specifically IFRS) has on pro forma disclosure frequency, disclosure characteristics and benchmarking. Findings – US-listed foreign firms applying IFRS report pro forma disclosures more frequently than firms using the USA’s generally accepted accounting principles (GAAP), but less opportunistically. Originality/value – This paper extends Epping and Wilder’s (2011) study and contributes to the pro forma disclosure literature by providing a cross-country analysis of non-GAAP disclosure based on reporting standard (IFRS or US GAAP). Understanding the non-GAAP disclosure of firms applying IFRS is useful to investors and regulators, as more countries adopt IFRS.

The Presentation Arrangements of Pro Forma Earnings Disclosures: Managerial Incentives and Market Responses

Different from prior studies which discussed the relationship between GAAP and pro forma earnings from the informativeness perspective, this study presents a detailed discussion about the importance of presentation arrangements of pro forma disclosures. The results show that managers are able to influence the market’s perception of earnings by using various presentation arrangements opportunistically. In addition, the results also show that the implement of Reg G, which requires detailed reconciliation between GAAP and pro forma earnings, effectively reduces such influence by 1) discouraging managers from using presentation arrangements to highlight favorable earnings opportunistically, 2) reinforcing the dominant position of GAAP earnings, and 3) reducing the influence of presentation arrangements over investors’ decision making. Together, this study supports the notion that Reg G indeed eliminates the excessive use of pro forma earnings and results in a more accurate pricing of earnings.

The Relation between Earnings Management and Pro Forma Reporting

Managers have a variety of tools at their disposal to influence stakeholder perceptions. Earnings management and the strategic reporting of non-GAAP (pro forma) performance metrics are just two of the many choices on the menu. We investigate how managers’ use of other menu items can influence the likelihood that they will disclose pro forma earnings. Specifically, we explore how (1) prior earnings management, current-period (2) operating performance, (3) real earnings management, and (4) accruals management influence the probability that a company will disclose an adjusted earnings metric in its earnings press release and the likelihood that it will do so aggressively. Based on a sample of hand-collected pro forma earnings disclosures, we find that companies that have used up their accruals in prior periods and that engage in less current-period earnings management are more likely to disclose pro forma earnings and to do so aggressively. Moreover, we find some evidence that companies using more real earnings management and with better current operating performance are less likely to report aggressive pro forma numbers. These results suggest that while more past earnings management is consistently positively associated with aggressive pro forma reporting, we find evidence of a substitute relation between aggressive pro forma reporting and both abnormal accruals and real earnings management. Finally, we find evidence that investors appear to understand these tradeoffs as they discount pro forma disclosures in the presence of higher levels of prior earnings management.

The Impact of Graphical Displays of Pro Forma Earnings Information on Professional and Nonprofessional Investors' Earnings Judgments

ABSTRACT:Regulation G (SEC 2003b) requires managers to reconcile textual non-GAAP performance measures (i.e., pro forma disclosures) to GAAP. Graphical disclosures also require reconciliation; however, neither the format nor the placement of the reconciliation is specified. We apply cognitive fit theory to argue that the influence of graphical information presentation formats is contingent on investor type and judgment complexity. Participants in our study viewed a simulated Investor Relations website for a large drug retailer and made judgments regarding current fiscal year earnings performance, earnings potential, and investment amount. We manipulated graphical (GAAP-only versus GAAP and pro forma) and textual (GAAP-only versus pro forma reconciled to GAAP) earnings disclosure content in a 2 × 2 between-participants design. We find that nonprofessional investors' current fiscal year earnings performance, earnings potential, and investment amount judgments are all influenced by graphical displays, which include pro forma as opposed to GAAP-only earnings information. Graphical displays of pro forma earnings information do not influence professional investors' current year earnings performance judgments; however, these displays do influence professional investors' earnings potential and investment amount judgments because they are more complex. Our results suggest a need to further examine the influence of graphical pro forma earnings presentation formats on investor judgments.Data Availability: Contact the first author.

Pro forma disclosures, audit fees, and auditor resignations

The disclosure of non-GAAP (pro forma) earnings numbers by managers in the post-SOX era continues to attract attention from regulators, media, and researchers. However, there is limited empirical evidence on how auditors view clients that emphasize pro forma earnings over GAAP earnings. We study the extent to which audit fees and auditor resignations are associated with opportunistic non-GAAP disclosures. We find that during the pre-SOX period, optimistic pro forma differences, measured using either IBES actual earnings or hand-collected pro forma earnings, are associated with higher audit fees and a higher likelihood of auditor resignations. Additional results indicate that auditors seem to be more concerned with non-GAAP earnings disclosures in the post-SOX period.

Investor Sentiment and Pro Forma Earnings Disclosures

ABSTRACTWe examine the influence of investor sentiment on managers’ discretionary disclosure of “pro forma” (adjusted) earnings metrics in earnings press releases. We find that managers’ propensity to disclose an adjusted earnings metric (especially one that exceeds the GAAP earnings number) increases with the level of investor sentiment. Furthermore, our analyses suggest that, as investor sentiment increases, managers: (1) exclude higher levels of both recurring and nonrecurring expenses in calculating the pro forma earnings number and (2) emphasize the pro forma figure by placing it more prominently within the earnings press release. Additional analyses indicate that the association between investor sentiment and managers’ pro forma disclosure decisions at least partly reflects opportunistic motives. Finally, we find that managers’ own sentiment‐driven expectations also play a role in their pro forma disclosure decisions.

Pertinence des différentes modalités de présentation et comptabilisation des régimes d'options d'achat d'actions

<titre>Résumé</titre>Cette étude examine la pertinence de l’information relative aux options d’achat d’actions (OAA) attribuées aux dirigeants et publiée ou comptabilisée en vertu des différentes modalités ayant eu cours au Canada entre 2000 et 2005. Les résultats des analyses, menées sur un échantillon d’entreprises cotées à la Bourse de Toronto, tendent à démontrer que la publication d’éléments d’information dans l’annexe tout comme la constatation d’une charge relative aux OAA dans le compte de résultat semblent pertinentes pour les investisseurs. La publication dans l’annexe de la charge pour options par l’intermédiaire d’un bénéfice pro forma ne semble toutefois pas présenter un contenu informationnel significatif.

The Valuation of Pro-Forma Free Cash Flows in an IPO Setting: The Case of Canadian Income Trusts

The Canadian income trust organizational structure allows operating entities to pass on free-cash flows to unit-holders in a tax-efficient manner. This paper examines the market valuation of pro forma disclosures of free cash flows, known as distributable cash, disclosed by these income trusts in IPO prospectuses and annual reports and assesses whether the market fixates inappropriately on this measure.We collect distributable cash disclosures for a sample of business trusts that undertook initial public offerings on the Toronto Stock Exchange between 1997 and 2006.We have several key findings. First, when focusing on a single performance measure, we find that distributable cash is a better predictor of IPO date trading values than is net income. Following the IPO distributable cash continues to be the best predictor of market value, out-performing both net income and dividends. Second, based on a Mishkin test, we find that the market does not fixate on distributable cash levels. Finally, though distributable cash does a good job of explaining price levels, we show it is incomplete. Special items, a component of net income that is excluded from distributable cash, is statistically significant when added to distributable cash. Similarly, net income can be very useful as a performance measure provided the researcher uses a more complex valuation mapping such as a returns format. In total, the results suggest that, for the flow-through entities we examine, distributable cash is a simple and useful disclosure that appears to be treated by the market as close to permanent earnings as defined in Ohlson (2009). The market is sophisticated in incorporating this disclosure. However, the superiority of one measure over another depends on the taste of the researcher for model complexity.

Pengungkapan Pro Forma, Mendukung atau Menyesatkan Investor?

Pro forma is originated from Latin. It contains different meaning depends on which discipline it is used. In accounting, pro forma disclosure is used to show effect of important transaction which occurs after the end of periods, or which occurs during period but not fully reflected in historical cost financial statement of a firm. Pro forma disclosure has the objective to support (but might mislead) investor in decision making focused on particular influence of important transaction. Company with low GAAP profit information; less profitable company and has higher level of debt but more liquid, whose P-E ratio and market to book is higher than other companies in the industry; has the tendency to do pro forma disclosure. Pro forma disclosure has been supported by several theories such as: efficient market theory, catering theory, agency theory, signaling theory, and stakeholder theory. However, there are problems in reporting pro forma figures. There is no standard to it. Therefore, information on pro forma disclosure might also mislead less sophisticated investor.

The Impact of Graphical Displays of Pro Forma Earnings Information on Professional and Nonprofessional Investors' Earnings Judgments

Regulation G (SEC 2003b) requires managers to reconcile textual non-GAAP performance measures (i.e., pro forma disclosures) to GAAP. Graphical disclosures also require reconciliation; however, neither the format nor the placement of the reconciliation is specified. We apply cognitive fit theory to argue that the influence of graphical information presentation formats is contingent on investor type and judgment complexity. Participants in our study viewed a simulated Investor Relations web site for a large drug retailer and made judgments regarding current fiscal year earnings performance, earnings potential, and investment amount. We manipulated graphical (GAAP-only vs. GAAP and pro forma), and textual (GAAP-only vs. pro forma reconciled to GAAP) earnings disclosure content in a 2 x 2 between-participants design. We find that nonprofessional investors’ current fiscal year earnings performance, earnings potential, and investment amount judgments are all influenced by graphical displays which include pro forma as opposed to GAAP-only earnings information. Graphical displays of pro forma earnings information do not influence professional investors’ current year earnings performance judgments; however, these displays do influence professional investors’ earnings potential and investment amount judgments because they are more complex. Our results suggest a need to further examine the influence of graphical pro forma earnings presentation formats on investor judgments.

Value Relevance of the Stock Options Disclosure or Reporting

This study investigates the relation between share price, stock-based compensation expense and information about employee stock options (ESO) disclosed in financial statement footnotes. Our results, for a sample of 750 observations over the period 2000-2005, suggest that the market values both the stock-based compensation expense recognized in financial statement and information about ESO disclosed in footnotes, but that ESO recognition in income statement or the pro forma disclosure showing the impact of expensing ESO on net income, are not as value relevant as the information disclosed in footnotes.

Disclosure versus Recognition of Stock Option Compensation: Effect on the Credit Decisions of Loan Officers

We examine if different stock option reporting formats affect bank loan officers' judgments and decisions. Three formats were used: (1) descriptive note of stock options plan only, (2) descriptive note that included a pro forma disclosure showing the impact of expensing the cost of stock options on net income, and (3) recognition of the stock options cost in the income statement. Our results show that loan officers estimated a higher risk rating and a more pessimistic trend rating, were less inclined to grant the loan, and charged a higher risk premium when the stock option expense was recognized in the income statement. Judgments and decisions did not significantly differ for the two methods of footnote disclosure, suggesting that loan officers are functionally fixated on reported earnings. Overall, our results support the FASB's claim that “disclosure is not an adequate substitute for recording.”

Pro forma disclosure and investor sophistication: External validation of experimental evidence using archival data

Insights on how ordinary, less-sophisticated investors interpret and process management-issued pro forma earnings numbers are useful to regulators because of concerns that pro forma disclosures are misleading to ordinary investors. Two recent experimental studies [Frederickson, J. R., & Miller, J. S. (2004). The effects of pro forma earnings disclosures on analysts’ and nonprofessional investors’ equity valuation judgments. The Accounting Review, 79(3), 667–686; Elliott, W. B. (2006). Are investors influenced by pro forma emphasis and reconciliations in earnings announcements? The Accounting Review, 81(1), 113–133] find that the existence of a pro forma number in the earnings press release as well as the relative placement of the pro forma and GAAP earnings figures within the press release affect the judgments of less-sophisticated investors but not those of more-sophisticated investors. Experimental and archival methodologies complement one another and results that persist in both settings are likely to be robust to both internal and external validity concerns. Therefore, we complement experimental evidence using trade-size-based proxies constructed from intraday transactions data to distinguish the trading activities of less-sophisticated investors from more-sophisticated investors. Our results suggest that less-sophisticated investors rely significantly more on quarterly earnings press releases that include a pro forma number than on those that do not, while more-sophisticated investors exhibit the opposite behavior. This result is consistent with Frederickson and Miller’s experimental evidence. Further, consistent with Elliott’s results, we find that less-sophisticated investors rely more on the pro forma figure when it is placed before the GAAP earnings number in the press release, while more-sophisticated investors’ trading behavior is unaffected by the relative placement of the two earnings metrics. We conclude that the existence of a pro forma number as well as its strategic placement in the press release generally affect the judgments of less-sophisticated (but not more-sophisticated) investors and these inferences are robust because they persist in both experimental and archival settings.

Are Investors Influenced by Pro Forma Emphasis and Reconciliations in Earnings Announcements?

This study presents the results of an experiment that examines how two underlying characteristics of pro forma earnings announcements, pro forma emphasis and the presence of a quantitative reconciliation, influence nonprofessional investors' and analysts' reliance on pro forma disclosures. The results indicate that the emphasis management places on pro forma earnings, not the mere presence of pro forma earnings, influences nonprofessional investors' judgments and decisions, but that this influence is mitigated by the presence of a quantitative reconciliation. Further analysis reveals that the influence of pro forma emphasis on nonprofessional investors' judgments and decisions seems to be the result of an unintentional cognitive effect as opposed to the perceived informativeness of the earnings figure emphasized by management. Analysts' judgments and decisions were also affected by the presence of reconciliation, but in the opposite direction to those of nonprofessional investors. Specifically, the presence of a quantitative reconciliation led analysts to view pro forma earnings as more reliable, increasing their reliance on the pro forma disclosure in judging the earnings performance of the firm.

Simulation of the Impact of the Recognition of Stock Options on the Earnings: The case of Canadian Companies*

One of the most controversial accounting issues pertains to stock compensation. In Canada, the Canadian Institute of Chartered Accountants (CICA) approved section 3870, Stock-based Compensation and Other Stock-Based Payments, on November 13, 2001, to take effect in January 2002. Section 3870 forces companies to “take a look at the real economic cost of most of the stock-based compensation mechanisms” (AcSB Bulletin, October 2001, 1). The adoption of section 3870 was aimed at harmonizing Canadian accounting practice with U.S. standards. The new standard, which was initially based on two American accounting standards - APB Opinion No. 25 and SFAS No. 123 - gave companies the choice of using either the fair value method or the pro forma disclosure of net income and adjusted earnings per share to account for stock-based compensation. The Accounting Standards Board (AcSB) nevertheless recommended that Canadian companies use the fair value method, which consists in estimating and recognizing the value of the stock options at the grant date.

VOLUNTARY DISCLOSURE PRACTICES: THE USE OF PRO FORMA REPORTING

This article looks at how U.S. managers supplement GAAP earnings with pro forma reporting. Pro forma measures, which are not audited, are typically determined through an adjustment to GAAP‐based earnings. For example, a manager may choose to present an alternative to GAAP earnings that excludes period write‐offs and one‐time restructuring charges in order to present a more value‐relevant picture of the company's performance.The authors find that 77% of S&amp;P 500 companies report pro forma results, and that pro forma measures are generally given greater prominence than GAAP earnings in corporate press releases. Based on the evidence, U.S. managers are using pro forma reporting strategically to affect investor perception of corporate performance. The SEC has recently issued rules to ensure that pro forma disclosure is not misleading. The authors present some guidelines on voluntary disclosure that might help forestall further regulation and preserve the ability to pursue this potentially informative practice.

The Effects of Pro Forma Earnings Disclosures on Analysts' and Nonprofessional Investors' Equity Valuation Judgments

This paper presents an experiment that examines the effect of pro forma earnings disclosures on the judgments of analysts (i.e., more sophisticated investors) and nonprofessional (i.e., less sophisticated) investors. In the experiment, participants developed stock price assessments after reviewing background financial information and a current earnings announcement for a company. The earnings announcement was manipulated to report only GAAP earnings in one condition and both pro forma and GAAP earnings in the other condition. Consistent with empirical evidence, the pro forma earnings in our experiment exceeded GAAP earnings. The results indicate that nonprofessional investors who received an earnings announcement that contained both pro forma and GAAP disclosures assessed a higher stock price than did nonprofessionals who received an announcement containing only GAAP disclosures. Financial analysts' stock price judgments were not affected by the pro forma disclosures. Followup analyses suggest that analysts and nonprofessional investors used different valuation models and information processing. Analysts used well-defined valuation models, based on either earnings-multiples or cash flows, while the nonprofessional investors were more likely to use simpler, heuristic-based valuation models. The pro forma disclosure did not cause nonprofessional investors to assess a higher earnings number for determining a stock price, but rather caused nonprofessionals to perceive the earnings announcement as more favorable, which in turn caused them to convert earnings or some other performance metric into a higher stock price. This effect appears to be due to unintentional cognitive effects, rather than nonprofessionals relying on pro forma earnings information because they perceived it to be informative.

Managing Pro Forma Stock Option Expense under SFAS No. 123

We investigate whether footnote disclosures under Statement of Financial Accounting Standards (SFAS) No. 123 are managed in 1996, the first year that the disclosure was required. The 1996 phase-in of SFAS No. 123 provided firms with a unique opportunity to manipulate the pro forma disclosure in the initial years. SFAS No. 123 allows firms discretion in estimating the value of their stock option grants and in allocating that value across accounting periods. Although we find little evidence that firms manage the estimated value of their option grants, we find that firm-specific incentives affect how that value is allocated. Specifically, firms that provide high levels of either CEO compensation or stock option compensation relative to performance allocate a smaller proportion of the options' value to the 1996 pro forma expense, apparently to reduce criticism of that compensation. Small firms and firms that recently went public also allocate a smaller proportion of option value to the 1996 pro forma expense, apparently to increase perceptions of their profitability. We conjecture that firms were less likely to manage the value of the options granted than the allocation of that value in 1996 because the parameter estimates underlying the reported option value must be disclosed in the footnote, whereas the inputs to the allocation computation are not disclosed. These results, which suggest that firms manipulated pro forma stock option expense when their estimate choices cannot be observed, have implications for both standard setters and financial statement users. In particular, the FASB's current deliberations on the transition from footnote disclosure to income statement recognition for stock options should consider additional disclosures to minimize unobservable choices. More generally, the FASB may reduce potential manipulation by requiring expanded disclosures about the choices used in computing both pro forma and reported numbers.