The Disclosure of Non-GAAP Earnings Information in the Presence of Transitory Gains

Abstract

We examine the disclosure of non-GAAP earnings information in quarters containing transitory gains to investigate whether the primary motivation for these managers to disclose non-GAAP earnings is to inform or mislead. In this setting, non-GAAP earnings are more informative than GAAP earnings, even though they are lower than GAAP earnings. Thus, managers motivated to inform stakeholders about sustainable earnings will disclose non-GAAP earnings information excluding the gain, whereas managers motivated to report higher earnings will obscure the transitory nature of the gain by focusing on GAAP earnings. We find evidence that managers' disclosure choices vary widely across firms, and these choices affect investors' perceptions of core operating earnings. We then contrast how the same firm discloses non-GAAP earnings in the presence of transitory losses to provide additional evidence on the motives of individual firms' disclosures. We conclude that the most pervasive motivation to disclose non-GAAP earnings in the presence of transitory gains is to inform. An economically significant proportion of firms, however, appear opportunistic in that they only disclose non-GAAP earnings information when it increases investors' perceptions of core operating earnings. Our evidence is important because we speak to the influence that each motive has on the choice to disclose non-GAAP earnings and we provide evidence on the underlying motives behind specific firms' disclosures. Data Availability: All data are available from the sources cited in the text.

Disentangling Managers’ and Analysts’ Non‐GAAP Reporting

“…In contrast, transitory items have greater explanatory power for exclusions in the I/B/E/S‐Only and Both‐Same scenarios than in the Manager‐Only scenario (columns 4–6). The primary reason that transitory items have lower explanatory power in the Manager‐Only scenario appears to be due to managers’ greater willingness to exclude income‐increasing transitory items ( Transitory_Pos_Value ) than income‐decreasing transitory items ( Transitory_Neg_Value ), consistent with Curtis, McVay, and Whipple [] and our table evidence. We do not find a similar asymmetry for transitory item exclusions in the Both‐Same and I/B/E/S‐Only scenarios.…”

“…Several other studies, however, find that some managers opportunistically calculate non‐GAAP earnings by excluding recurring earnings components (e.g., Doyle, Lundholm, and Soliman [], Barth, Gow, and Taylor []), classifying recurring earnings components as transitory (Kolev, Marquardt, and McVay []), and strategically excluding items to meet earnings benchmarks (e.g., Black and Christensen [], Doyle, Jennings, and Soliman []) . Opportunistic incentives can also discourage managers from disclosing informative non‐GAAP metrics, such as when the non‐GAAP metric is lower than GAAP earnings (Curtis, McVay, and Whipple []). Managers also face higher disclosure costs, compared to analysts, which might deter informative non‐GAAP reporting.…”

Non‐GAAP Earnings Disclosure in Loss Firms

“…That is, if managers exclude expenses in the calculation of non‐GAAP earnings, Non‐GAAP earnings will exceed GAAP earnings and the Exclusions variable will be negative and equal to the magnitude of the excluded expenses (Whipple []). Following Kolev, Marquardt, and McVay [], Curtis, McVay, and Whipple [], and BCGW, Controls is a vector of common control variables, that is, firm size, age, growth opportunities, and earnings volatility. In addition, untabulated year‐quarter and industry fixed effects are included in the estimation.…”

“…A matter that complicates the empirical identification of informative versus opportunistic motivations for non‐GAAP reporting is that both explanations predict that managers disclose non‐GAAP earnings that are greater than GAAP earnings because uninformative transitory items tend to be income‐decreasing and managers are assumed to have stronger incentives to inflate rather than deflate perceptions of firm performance. Curtis, McVay, and Whipple [] circumvent this problem by focusing on the exclusion of transitory gains. They find that firms’ primary motivation to exclude transitory gains from non‐GAAP earnings is to inform investors.…”

The Ethical Reporting of Non-GAAP Performance Measures

“…The dollar amount of cost adjustments made to those companies' profits totaled $132 billion last year, more than double the amount in 2009 (Morgenson, 2015). Prior research debates whether these 'manager-customized' earnings provide investors with a clearer picture for forecasting future operating performance (not conveyed by GAAP earnings) or simply portray an overly optimistic depiction of performance (Bhattacharya, Black, Christensen, & Larson 2003;Curtis, McVay, & Whipple, 2014). This skepticism about non-GAAP reporting stems from the fact that these earnings disclosures are not audited, therefore, allow managers increased discretion in providing non-standard performance metrics.…”