Comparative Value-Relevance of GAAP, IBES, S&P Core, Cash Earnings and Cash Flows

Abstract

This study examines the impact the global financial crisis had on the value relevance of GAAP and non-GAAP earnings. We adopt the Ohlson (1995) valuation and CAR models to test the value relevance and information content of alternative earnings measures. We use six different earnings measures comprising IBES earnings, Standard & Poor's (S&P) core earnings, cash earnings, cash flows from operations, earnings from operations adjusted to exclude special items under GAAP and income before extraordinary items under GAAP. We draw our sample from US publicly traded firms between 2002 and 2010. Our sample is partitioned into Financial and non-Financial firms, and S&P 500 and non-S&P 500 firms. The results show that investors place greater value relevance on GAAP earnings during the GFC period relative to the pre-GFC period. INTRODUCTIONThere is much research on the information content and value relevance of earnings measures based on generally accepted accounting principles (GAAP) relative to non-GAAP measures.Prior research (Bradshaw and Sloan, 2002; Bhattacharya et al., 2003; Doyle et al., 2003;Lougee and Marquardt, 2004) finds that non-GAAP earnings (e.g., street, pro forma or IBES earnings) are significantly more value relevant and informative relative to GAAP earnings.Much of this evidence, however, is based on samples from before 2006, i.e., before the global financial crisis (GFC). Consequently, these studies do not investigate the impact of the GFC on the value relevance or informativeness of non-GAAP earnings relative to GAAP earnings. Albring et al. (2010), however, covers the period 2002 to 2007 in their study, which includes the beginning of the GFC. Nevertheless, they did not investigate the impact of the GFC. To the best of our knowledge, there is no research on the value relevance of these earnings metrics post-2006 after the GFC, during which period there is increased focus on the reliability of earnings information. Further, the GFC has created a climate of volatility and uncertainty in the capital market that may impact on how investors perceive the credibility and value relevance of earnings, and the sources from which they are produced. Prior to the GFC, there had been concerns with pro forma earnings, specifically with the quality of the information and the potential for it to be biased given management's vested interests. This led to the Securities and Exchange Commission (SEC) instituting regulations limiting the use of non-GAAP earnings metrics (SEC, 2001; SEC, 2002 Generally, pro forma earnings are produced by firms to supplement their reported GAAP earnings, while street and IBES earnings are produced by analysts. Non-GAAP earnings are generally more selective than GAAP earnings in that "other non-operating" items are excluded and these earnings are argued to better represent continuing performance. Bowen et al. (2005) provide evidence that firms tend to place greater relative emphasis on pro forma earnings when they have less value relevant GAAP earnings. Bhattacharya et al. (2003)...