Non‐GAAP reporting: Evidence from academia and current practice

Abstract

The number of firms reporting earnings on a non-GAAP basis has increased dramatically over the last decade, and non-GAAP reporting is now commonplace in capital markets. This proliferation of non-GAAP reporting has renewed both regulators' and standard setters' interests in these alternative performance metrics. For example, the SEC, FASB, and IASB have all recently questioned what this increasing reporting trend means for IFRS-and US-GAAP-based reporting and whether these measures are misleading to investors. This increasing focus on non-GAAP metrics motivates us to synthesize the nearly two decades of research on non-GAAP reporting to provide insights on what academics have learned to date about this reporting practice. Then, we utilize a novel dataset of detailed non-GAAP disclosures to provide new descriptive evidence on current trends in non-GAAP reporting and its recent proliferation. Finally, we discuss important questions for future researchers to consider in moving the literature forward. K E Y W O R D Snon-GAAP earnings, regulation, standard setting INTRODUCTIONManagers, financial analysts, investors, lenders, compensation committees, and other stakeholders often evaluate a company's earnings performance using metrics other than GAAP-based net income. These stakeholders generally start with GAAP earnings and back out (or exclude) earnings components that they deem to be transitory or noncash. They argue that these excluded items are less relevant for assessing firm performance and that the "non-GAAP" performance number is more appropriate for their intended purposes. The growth in these non-GAAP metrics over the past 20 years reflects a widespread acceptance of non-standard performance metrics as a way to evaluate firm performance.Although skeptics have frequently viewed non-GAAP disclosure as a threat to the traditional GAAP-based income statement, regulators recognize that non-GAAP metrics can be informative to investors and have laid the groundwork for firms to disclose these metrics in a transparent manner. Standard setters and regulators have recently renewed J Bus Fin Acc. 2018;45:259-294. wileyonlinelibrary.com/journal/jbfa

Executive Compensation and Financial Performance Measures: Evidence from Significant Financial Institutions

“…While numerous studies have examined the determinants of the use of non-GAAP for external reporting purposes, the results are best described as mixed. 10 While some studies have yielded evidence consistent with the explanation that non-GAAP performance measures provide useful additional information (Bhattacharya et al 2003;Marques 2006;Entwistle et al 2010;Black et al 2018), there is also evidence consistent with the self-serving explanation for the promotion and disclosure of non-GAAP measures (Bhattacharya et al 2004;Black and Christensen 2009;Barth et al 2012;Isidro and Marques 2013). More recently, Ribeiro et al (2019) provide evidence which suggests that the voluntary disclosure of non-GAAP performance measures reflects the undoing of inherent conservatism, such that non-GAAP measures are more predictable and valuerelevant, and less conservative, than their closest statutory GAAP equivalents.…”

Non-GAAP Earnings and the Earnings Quality Trade-off

“…We also disregard studies that do not examine actual non-GAAP disclosures, but instead rely on substitutes such as analysts' forecasts. Black et al (2018) and Coulton et al (2016) both provide detailed summaries of prior research. around earnings announcement dates and forecast revisions.…”

Effects of winsorization: The cases of forecasting non‐GAAP and GAAP earnings

“…I employ both GAAP and non‐GAAP earnings forecasts to formally examine the effect of winsorization, with particular focus on the non‐GAAP measure because of its availability, importance and relevance to investors and other stakeholders (see, e.g., Bentley, Christensen, Gee, & Whipple, ; Black et al., ; Bradshaw & Sloan, ; Brown & Sivakumar, ; Hoogervorst, ; Wieland, Dawkins, & Dugan, ). I use both unscaled and scaled earnings specifications including total earnings, earnings per share (EPS) and earnings yield (EY) .…”

“…Hence, while claiming to outperform the forecasts of financial analysts in terms of accuracy, their results may be limited to a specific sample and potential distortions by the winsorization process are largely ignored. Second, the use of earnings forecasts in the pricing of stocks and in portfolio formation (see, e.g., Black, Christensen, Ciesielski, & Whipple, 2018;Bradshaw & Sloan, 2002;Bradshaw, Christensen, Gee, & Whipple, 2018) allows me to look beyond conclusions offered by existing studies on winsorization, such as Leone et al (2017), by also considering the impact of winsorization on economic values.…”

“…Here, winsorization of companies in the tails appears to be non-systematic and the impact of winsorization on economic values is less likely to be serious. I employ both GAAP and non-GAAP earnings forecasts to formally examine the effect of winsorization, with particular focus on the non-GAAP measure because of its availability, importance and relevance to investors and other stakeholders (see, e.g., Bentley, Christensen, Gee, & Whipple, 2018;Black et al, 2018;Bradshaw & Sloan, 2002;Brown & Sivakumar, 2003;Hoogervorst, 2016;Wieland, Dawkins, & Dugan, 2013). I use both unscaled and scaled earnings 1 Non-GAAP ("Street") earnings numbers are the figures announced by corporations in their press releases and tracked by analyst estimate clearinghouse services (Bradshaw & Sloan, 2002).…”