Pro Forma Earnings Disclosures Research Articles

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

This study examines whether the presentation of pro forma earnings disclosures within earnings announcements reflects managerial incentives, as well as the impact of these presentation decisions on equity market pricing of earnings. Using hand-collected data, I measure “presentation” along two dimensions: emphasis of pro forma earnings within the earnings announcement, and the display format of earnings. Consistent with expectations, I document three empirical regularities. First, these presentation decisions appear to reflect managerial opportunism, such as the desire to beat benchmark earnings. Second, these decisions affect the market reaction to disclosed earnings. Finally, implementation of Regulation G, which mandated improved reconciliation of pro forma earnings to GAAP earnings, reduces both opportunistic presentation as well as the influence of presentation arrangements over investors’ decision making. Overall, the results suggest that presentation of pro forma earnings also reflects managerial incentives and market pricing, and that regulatory efforts to mitigate these effects have been successful.

The role of reconciliation quality in limiting mispricing of non-GAAP earnings announcements by EURO STOXX firms

This empirical study investigates the relationship between the market mispricing of pro forma earnings announcements and the degree to which pro forma earnings are quantitatively reconciled with GAAP (Generally Accepted Accounting Principles) earnings. For a sample of EURO STOXX Fixed Index companies we find evidence of positive abnormal returns related to pro forma earnings disclosures, and, upon further analyses, conclude that this evidence is generally more consistent with the notion of market mispricing than omitted risk factors. Moreover, when reconciliation quality is controlled, market mispricing is found to be prevalent and pronounced only for low quality reconciliations. This finding suggests that reconciliation is important in reducing market mispricing.

Optimistic Reporting and Pessimistic Investing: Do Pro Forma Earnings Disclosures Attract Short Sellers?

Contemporary Accounting ResearchVolume 31, Issue 1 p. 67-102 Article Optimistic Reporting and Pessimistic Investing: Do Pro Forma Earnings Disclosures Attract Short Sellers?† Theodore E. Christensen, Theodore E. Christensen Brigham Young UniversitySearch for more papers by this authorMichael S. Drake, Michael S. Drake Brigham Young UniversitySearch for more papers by this authorJacob R. Thornock, Jacob R. Thornock University of WashingtonSearch for more papers by this author Theodore E. Christensen, Theodore E. Christensen Brigham Young UniversitySearch for more papers by this authorMichael S. Drake, Michael S. Drake Brigham Young UniversitySearch for more papers by this authorJacob R. Thornock, Jacob R. Thornock University of WashingtonSearch for more papers by this author First published: 09 October 2012 https://doi.org/10.1111/1911-3846.12009Citations: 65 † Accepted by Mary Harris Stanford. We appreciate helpful comments from Mary Harris Stanford and two anonymous referees that significantly improved the paper. We also appreciate suggestions from Bob Bowen, Rick Mergenthaler, Kari Olsen, Mark Soliman, Ed Swanson, Jeff Wilks, David Wood, and participants at the Brigham Young University, IE Business School, Santa Clara University, and Texas A&M University workshops. We are especially grateful to Jenny Tucker for help and insights into modeling self-selection. We appreciate the valuable research assistance of Minkwan Ahn, Kris Allee, Joe Bartlett, Jeff Bednar, Dirk Black, Bryant Blanchard, Brandon Buhler, Brandon Butler, Nathan DeFries, Leo Ebbert, Jonathan Fife, Josh Gagon, Kirk Gibb, Bryan Graden, Nick Guest, Jeff Hoopes, Alicia Ingalls, Rob Jenson, Robert Judd, Chad Larson, Jon Liljegren, Sam Mautz, Derek Moody, Greg Packer, Spencer Pierce, Heidi Prescott, John Prete, Willis Pueblo, Rob Shaw, Jacob Smith, Roy Schmardebeck, Dale Stewart, Scott Tandberg, Patrick Walsh, Adam Ward, Chris Williams, Devin Williams, Ty Woods, Donnie Young, and Luke Zimmerman. Christensen expresses appreciation to Brigham Young University for student mentoring grants that made this research possible. Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinkedInRedditWechat Citing Literature Volume31, Issue1Spring 2014Pages 67-102 RelatedInformation

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.

CEO Compensation Incentives and Pro Forma Earnings Disclosures

We examine the relation between compensation incentives and non-GAAP earnings disclosures. Specifically, we focus on the extent to which bonus plan incentives and long-term performance plan incentives are associated with the aggressiveness of non-GAAP reporting, controlling for CEO sensitivity to stock price. Using a large hand-collected sample of non-GAAP earnings disclosures, we find that long-term plan incentives are negatively associated with the likelihood and magnitude of aggressive non-GAAP reporting, suggesting that they act as a deterrent to potentially opportunistic behavior. For a sub-sample of firms for which compensation contracts in proxy filings explicitly state that managers will be evaluated based on non-GAAP metrics, we find less opportunistic non-GAAP reporting, consistent with boards defining adjusted performance metrics in compensation contracts in order to limit CEOs’ ability to define their own non-GAAP numbers. However, when boards of directors have discretion to use non-GAAP metrics when evaluating managers, we find more opportunistic non-GAAP earnings reporting, consistent with managers using the flexibility in contracts to influence their performance evaluations.

Has the Regulation of Pro Forma Reporting in the US Changed Investors’ Perceptions of Pro Forma Earnings Disclosures?

Abstract: We explore whether investors’ perceptions of pro forma earnings numbers have changed following the regulation of pro forma reporting imposed by the Sarbanes‐Oxley Act of 2002 (SOX). First, we find that investors appear to pay more attention to pro forma earnings disclosures in the post‐SOX period, consistent with the notion that they perceive that regulation generally renders these disclosures more credible. Second, the results indicate that investors discount aggressive pro forma earnings reports in both periods. However, they appear to discount at least some potentially misleading pro forma earnings disclosures more in the post‐SOX period. Finally, our results imply that the regulation of pro forma reporting has increased the average quality of pro forma earnings disclosures by filtering out those that are most likely to be misleading. These results are consistent with the conclusions that (1) the quality of pro forma reporting has improved following SOX, and (2) investors’ perceptions of pro forma earnings metrics have changed in the post‐SOX regulatory environment.

Has the Regulation of Pro Forma Reporting in the U.S. Changed Investors’ Perceptions of Pro Forma Earnings Disclosures?

We explore whether investors’ perceptions of pro forma earnings numbers have changed following the regulation of pro forma reporting imposed by the Sarbanes-Oxley Act of 2002 (SOX). First, we find that investors appear to pay more attention to pro forma earnings disclosures in the post-SOX period, consistent with the notion that they perceive that regulation generally renders these disclosures more credible. Second, the results indicate that investors discount aggressive pro forma earnings reports in both periods. However, they appear to discount at least some potentially misleading pro forma earnings disclosures more in the post-SOX period. Finally, our results imply that the regulation of pro forma reporting has increased the average quality of pro forma earnings disclosures by filtering out those that are most likely to be misleading. These results are consistent with the conclusions that (1) the quality of pro forma reporting has improved following SOX, and (2) investors’ perceptions of pro forma earnings metrics have changed in the post-SOX regulatory environment.

Information versus adverse Anlegerbeeinflussung: Befund und Implikationen der empirischen Rechnungswesenforschung zur Publizität von Pro-forma-Ergebnisgrößen

Pro forma earnings represent voluntarily disclosed performance metrics that modify the mandatory (GAAP) income number. Motives discussed to explain this disclosure phenomenon are to increase the informativeness of earnings (information), or to influence investors in an adverse fashion (opportunism). The objective of this paper is to survey the extant US and German literature pertaining to pro forma earnings disclosures, with a special emphasis on the ensuing regulatory discussion, to point out promising avenues for future research. Extant studies, on the one hand, demonstrate evidence in favour of (incremental) informativeness (value relevance, information content) of pro forma earnings. On the other hand, they find evidence that small investors in particular tend to process pro forma earnings information in an undue fashion. In the light of evidence that demonstrates extensive use of pro forma earnings disclosures by large German corporations, this research literature lends support to recent concerns voiced by European securities regulators, and points at avenues for future research into capital markets reception of pro forma earnings disclosures both on the German capital market and in an EU/IFRS context.

Information Versus Strategic Reporting: Determinants of the Disclosure of Pro Forma Earnings by Large German Corporations

This paper investigates the determinants of firms’ decisions to disclose ‘pro forma’ earnings, voluntarily performance metrics, in a largely unregulated setting, the German capital market. For a sample of earnings releases published by large German firms, we address the role of informative and strategic motives for the disclosure of such voluntary performance metrics, and investigate effects of first-time IFRS adoption. Results indicate that incentives to meet earnings benchmarks play a significant role in the decision to disclose pro forma earnings and are positively associated with relative reporting emphasis assigned to these metrics. On the other hand, we find no evidence that firms use pro forma earnings to compensate for low quality of reported GAAP earnings. Consistent with an informative endeavor, voluntary adopters of IFRS are significantly less likely to use pro forma earnings disclosures and to assign reporting emphasis than mandatory adopters. Taken together, these results suggest that regulatory concern may be warranted, and point out the need for further capital markets based studies.

Optimistic Reporting and Pessimistic Investing: Do Pro Forma Earnings Disclosures Attract Short Sellers?

We contribute to the debate regarding the informativeness of pro forma earnings disclosures by providing evidence that a group of informed traders, short sellers, trade as if firms’ voluntary non-GAAP earnings disclosures create information advantages they can exploit. While prior research indicates that short sellers identify firms that will experience declining operating performance, we investigate whether the disclosure of pro forma earnings acts as an indicator of future price declines that is distinct from poor operating performance. We find that short selling is significantly higher in quarters in which firms disclose non-GAAP earnings metrics relative to quarters in which they do not disclose adjusted earnings measures. Moreover, we find that short selling is significantly positively associated with the exclusion of recurring items and, more particularly, with the exclusion of stock-based compensation. We also find some evidence that short sellers trade more when managers exclude expense items to appear to meet analysts’ expectations on a pro forma basis when they fall short of expectations based on GAAP operating earnings. Finally, we find evidence based on abnormal returns suggesting that short sellers profit from short selling around earnings announcements containing pro forma earnings disclosures. Overall, the results are consistent with the notion that sophisticated market participants view pro forma earnings disclosures negatively and trade in order to take advantage of potential information asymmetries created by these disclosures.

Do Managers Use Pro Forma Earnings Disclosures to Cater to Investor Sentiment?*

Do Managers Use Pro Forma Earnings Disclosures to Cater to Investor Sentiment?*

Who Trades on Pro Forma Earnings Information?

In recent years, many companies have emphasized adjusted-GAAP earnings numbers in their quarterly press releases. While managers use different names to describe these nonstandard earnings metrics, the financial press frequently refers to them as “pro forma” earnings. Managers and other advocates of pro forma reporting argue that these disclosures provide a clearer picture of companies' core earnings. On the other hand, regulators, policymakers, and the financial press often allege that managers' pro forma earnings disclosures are opportunistic attempts to mislead investors. Recent evidence suggests that while many pro forma earnings disclosures are altruistically motivated, some may represent managers' attempts to portray overly optimistic financial performance. If this is the case, then less wealthy, less sophisticated, individual investors are arguably the most at risk of being misled. Consequently, this study investigates who trades on pro forma earnings information. Our intraday investigation of transactions around earnings announcements containing pro forma earnings information reveals that less sophisticated investors' announcement-period abnormal trading is significantly positively associated with the magnitude and direction of the earnings surprise based on pro forma earnings. In contrast, we find no association between sophisticated investors' trading and manager-reported pro forma information. Overall, our analyses and numerous robustness tests suggest that the segment of the market that relies on pro forma earnings information is populated predominantly by less sophisticated individual investors. This evidence is particularly relevant to standard-setters and regulators given that Section 401(b) of the Sarbanes-Oxley Act of 2002 and subsequent SEC regulations are specifically designed to protect ordinary investors from misleading pro forma information.

Voluntary Disclosure of Disaggregated Earnings Information

This paper provides an equilibrium analysis of a setting in which a manager is required to disclose GAAP earnings, but has discretion over the provision of information about earnings components that are disaggregated according to their persistence or value relevance. We find that the manager is more likely to disclose disaggregated earnings information when GAAP earnings fall. We derive intuitive comparative static results concerning the impacts of firm characteristics on the manager's equilibrium disclosure choice. We also discuss how the paper's main results are linked to empirical findings on pro forma earnings disclosures.

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.

Pro Forma Earnings Disclosures: Do Analysts and Nonprofessional Investors React Differently?

The increase in the number of firms disclosing pro forma earnings in their earnings announcements in addition to disclosing earnings calculated according to generally accepted accounting principles (GAAP) has prompted regulators, Congress, and the financial press to voice concerns about pro forma earnings. A major concern is that pro forma earnings disclosures affect less sophisticated and more sophisticated investors differently. This paper presents an experiment that examines the effect of pro forma earnings disclosures on the judgments of nonprofessional (i.e., less sophisticated) investors and analysts (i.e., more sophisticated investors). Consistent with empirical evidence, the pro forma earnings in our experiment exceeded GAAP earnings. The results indicate that nonprofessional investors who see an earnings announcement that contains both pro forma and GAAP disclosures assess a higher stock price than do nonprofessionals who see an earnings announcement that contains only GAAP disclosures, whereas analysts' stock price judgments are not affected. Follow-up analyses suggest that the differential effect of the pro forma disclosure is due to analysts and nonprofessional investors using different valuation models and information processing. Analysts used well-defined valuation models, based on either earnings multiples or cash flows, while the nonprofessional investors generally used simpler, heuristic-based valuation models. The pro forma disclosure also caused nonprofessionals to perceive the earnings announcement as more favorable, which in turn caused them to assess a higher stock price. This effect appears to be due to unintentional cognitive effects, rather than nonprofessionals relying on the pro forma earnings information because they perceived it to be informative.