Non‐GAAP earnings disclosure post 2010 SEC regulation change

Abstract

In this article, we explore the disclosure of non‐GAAP earnings by large, publicly traded companies, and the possible impact of the 2010 change in Regulation G and S‐K on corporate reporting behavior. The reporting of non‐GAAP earnings measures is not required for public companies, nor are these measures audited. There exists considerable leeway in the manner and extent to which companies can report and calculate non‐Generally Accepted Accounting Principles (GAAP) earnings. Not surprisingly, non‐GAAP reporting standards are a concern for regulators trying to uphold the consistency and comparability of financial reporting. We collected the fourth quarter earnings releases of Standard and Poor's (S&P) 100 companies for the years 2010 through 2016 to study their reported annual non‐GAAP earnings disclosures, if any. Adjustments made to GAAP earnings were classified into eight common categories (e.g., Restructuring Charges, Tax Related Benefits/Charges) in order to calculate the magnitude, materiality, and nature of the adjustments reported. Our analysis shows that the number of companies reporting non‐GAAP earnings increased over our period of study, with a significant increase occurring after the 2010 liberalization of the Regulation G rules. We found an increase in all categories of adjustments and that most were −10% to +10% of net income. The median values of adjustments were positive in almost all the categories indicating non‐GAAP adjustments generally increase non‐GAAP net earnings. We observed many instances of companies reporting the same category of non‐GAAP earnings over multiple years. Further, we find that companies that do not report non‐GAAP earnings have higher market capitalizations than non‐GAAP earnings reporters. This study contributes to the research of non‐GAAP earnings reporting with an extensive analysis of the disclosure, the nature and magnitude of adjustments companies report, and the characteristics of those companies that choose to disclose.

The use of non‐GAAP measures in initial public offerings

“…Next, we document a positive and statistically significant coefficient for INTANG , indicating that firms with a higher proportion of intangible assets are more likely to report NGMs in their IPO filing. This evidence is also consistent with the findings of prior studies that amortizations and impairments of intangible assets are popular items excluded by public firms Heflin & Hsu, 2008; Kolev et al, 2008; Henry et al, 2020). In terms of the economic significance of the impact, an increase in the value of INTANG from the 10 percentile to the 90 percentile of the sample on average leads to ~17% increase in the probability of disclosing NGMs in the IPO filing.…”

“…Thus, managers of these firms may attempt to help investors better understand firm performance by disclosing adjusted earnings measures. In fact, amortizations and impairments of intangible assets are common exclusions made by firms reporting NGMs (Brown, Christensen, Menini, & Steffen, 2018; Heflin & Hsu, 2008; Henry, Weitz, & Rosenthal, 2020; Kolev, Marquardt, & McVay, 2008). While Lougee and Marquardt (2004) do not find reliable evidence that intangible asset intensity is significantly associated with the likelihood of disclosing NGMs in earnings press release, Curtis, Li, and Patrick (2018) show that boards are more likely to use adjusted earnings in CEO compensation contracts for firms with a higher proportion of intangible assets.…”

Alternative Performance Measures: A Structured Literature Review of Research in Academic and Professional Journals

“…In addition, APM reporting has historically been favoured by a relatively low level of regulation, resulting in significant degrees of freedom (Henry et al. 2020 b).…”

Non‐generally accepted accounting principles disclosures and audit committee chairs’ external directorships

“…For instance, prior studies emphasize the fact that firms sometimes exclude recurring expenditures such as depreciation, research and development costs and stock‐based compensation, and this practice may be associated with managers’ incentives to meet market expectations (Brown et al., 2012; Doyle et al., 2013; Frankel et al., 2011; Kiosse, 2009; Marques, 2006). Recent studies express concerns about managers opportunistically using their discretion in defining non‐GAAP earnings because this type of aggressive reporting could mislead investors and analysts (Bond et al., 2017; Henry et al., 2017, 2019; Webber et al., 2013). Regulators are apprehensive about the practice of excluding recurring items (SEC, 2018) and the potential of non‐GAAP earnings to mislead investors (Bricker, 2019).…”