Research

Publications

The Determinants and Informativeness of Non-GAAP Revenue Disclosures (The Accounting Review, Forthcoming), with John Campbell and Zac Wiebe

Nearly all research on non-GAAP financial measures focuses on earnings or earnings per share, although non-GAAP revenue disclosure has recently attracted SEC scrutiny. It is unclear ex ante what non-GAAP adjustments could improve revenue’s usefulness because, unlike earnings, revenue is a top-line number related primarily to core (i.e., persistent) business activities. We present the first archival analysis of non-GAAP revenues based on a large, hand-collected sample of disclosures from 2015-2018. Approximately one in five earnings announcements contains a non-GAAP revenue disclosure, focused on revenue growth. Our evidence suggests that firms disclose non-GAAP revenue when GAAP revenue is incomparable with prior periods, and not to compensate for poor GAAP performance. Furthermore, non-GAAP revenue growth predicts future revenue growth better than GAAP revenue growth, and the market responds to this information. Overall, non-GAAP revenue disclosures are motivated by economic fundamentals rather than opportunism, on average, and they provide investors with relevant information.

CEO Pay Components and Aggressive Non-GAAP Earnings Disclosure (Journal of Accounting, Auditing, & Finance, Forthcoming), with Dirk Black, Ervin Black, and Theodore Christensen

We examine the relation between CEO pay components and aggressive non-GAAP earnings disclosures using CEO pay components as proxies for managers’ short- versus long-term focus. Specifically, we explore the extent to which short-term bonus plan payouts and long-term incentive plan payouts are associated with: (1) Managers’ propensity to exclude expense items in excess of those excluded by equity analysts; and, (2) The magnitude of those incremental exclusions. We find that long-term incentive plan payouts are negatively associated with the likelihood and magnitude of aggressive non-GAAP exclusions. Our results are consistent with managers reporting non-GAAP information less aggressively when they are more focused on long-term, rather than short-term, value.

Comparing Non-GAAP EPS in Earnings Announcements and Proxy Statements (Management Science, 2022), with Dirk Black, Ervin Black, and Theodore Christensen

We compare non-GAAP EPS in firms’ annual earnings announcements and proxy statements using hand-collected data from SEC filings. We find that proxies for capital market incentives (contracting incentives) are more highly associated with firms’ disclosure of non-GAAP EPS in annual earnings announcements (proxy statements). However, we find systematic differences in the properties of firms’ non-GAAP earnings and exclusions depending on whether they disclose non-GAAP EPS in both the earnings announcement and the proxy statement. When firms disclose non-GAAP EPS in both documents, we find that non-GAAP EPS is more useful for assessing firm value. Specifically, these firms are more likely to: (1) Exclude nonrecurring items; (2) Exclude less persistent earnings components; and, (3) Provide less aggressive non-GAAP EPS. Our results suggest that non-GAAP EPS is higher in quality for investors when disclosed in both the annual earnings announcement and the proxy statement. We provide the first large-sample evidence consistent with the use of non-GAAP EPS metrics in both financial reporting and compensation contracting.

Stock Price Management and Share Issuance: Evidence from Equity Warrants (The Accounting Review, 2021), with Mary Barth, Doron Israeli, and Ron Kasznik

We investigate whether firms manage stock prices in anticipation of share issuance. Warrant exercise results in share issuance and warrant expiration dates are fixed years in advance, which precludes market timing. We predict firms manage stock prices to prevent (induce) warrant exercise when exercise is dilutive (anti-dilutive) to existing shareholders. To test our prediction, we examine stock returns around warrant expiration dates. We find that the difference between out-of-the-money (OTM) and in-the-money (ITM) firms’ return patterns (i.e., post-expiration minus pre-expiration returns) is positive, and OTM (ITM) firms’ return pattern is positive (negative). Return patterns of three sets of pseudo warrant firms differ from patterns of warrant firms. Return patterns are stronger when more feasible price changes are required to affect warrant expiration status, and firm-issued news items is a mechanism for price management. Thus, our findings provide evidence that firms engage in stock price management in anticipation of share issuance.

Disclosure Prominence and the Quality of Non-GAAP Earnings (Journal of Accounting Research, 2021), with Jason Chen and Jed Neilson

The SEC prohibits the presentation of non-GAAP measures before corresponding GAAP measures; however, a large proportion of non-GAAP reporters present non-GAAP EPS before GAAP EPS in their earnings announcements. This noncompliance raises questions about whether firms use prominence to highlight higher- or lower-quality non-GAAP information. For firms reporting non-GAAP EPS between 2003 and 2016, prominent non-GAAP EPS is associated with higher-quality non-GAAP reporting. Further tests reveal that nonregulatory incentives, rather than regulatory costs, explain this relation. Specifically, prominence is associated with higher-quality non-GAAP reporting in settings where prominence is not regulated, investors ignore prominence when non-GAAP reporting quality is lower, and the minority of firms using prominence to mislead exhibit characteristics associated with weaker investor monitoring. Overall, we provide evidence that regulatory noncompliance can reflect an intent to inform, and that most firms use prominence to highlight higher-quality non-GAAP information despite prohibitive regulation.

Analysts’ GAAP earnings forecasts and their implications for accounting research (Journal of Accounting and Economics, 2018), with Mark Bradshaw, Theodore Christensen, and Benjamin Whipple

We use newly available GAAP forecasts to document that traditionally-identified GAAP forecast errors contain 37% measurement error. Correcting for this measurement error, we settle a long-standing debate regarding investor preference for GAAP versus non-GAAP earnings and provide strong evidence of a preference for non-GAAP earnings. We also revisit the use of non-GAAP exclusions to meet analysts’ forecasts when GAAP earnings fall short. Results indicate that 34% of these traditionally-identified meet-or-beat firms are misidentified due to measurement error, and this error masks evidence that firms more frequently exclude transitory rather than recurring expenses for meet-or-beat purposes.

Disentangling Managers' and Analysts' Non-GAAP Reporting (Journal of Accounting Research, 2018), with Jeremiah Bentley, Theodore Christensen, and Benjamin Whipple

Researchers frequently proxy for managers’ non‐GAAP disclosures using performance metrics available through analyst forecast data providers (FDPs), such as I/B/E/S. The extent to which FDP‐provided earnings are a valid proxy for managers’ non‐GAAP reporting, however, has been debated extensively. We explore this important question by creating the first large‐sample data set of managers’ non‐GAAP earnings disclosures, which we directly compare to I/B/E/S data. Although we find a substantial overlap between the two data sets, we also find that they differ in systematic ways because I/B/E/S (1) excludes managers’ lower quality non‐GAAP numbers and (2) sometimes provides higher quality non‐GAAP measures that managers do not explicitly disclose. Our results indicate that using I/B/E/S to identify managers’ non‐GAAP disclosures significantly underestimates the aggressiveness of their reporting choices. We encourage researchers interested in managers’ non‐GAAP reporting to use our newly available data set of manager‐disclosed non‐GAAP metrics because it more accurately captures managers’ reporting choices.

March Market Madness: The Impact of Value-Irrelevant Events on the Market Pricing of Earnings News (Contemporary Accounting Research, 2016), with Michael Drake and Jacob Thornock

Each year, the NCAA basketball tournament (March Madness) is a daytime distraction for millions of people, providing a largely exogenous shock to investor attention. We investigate whether March Madness influences the market response to earnings by diverting investor attention away from earnings news. We find that the price reaction to earnings news released during March Madness is muted. This result generally holds across several samples and additional analyses. We also find that the result is more muted for low institutional ownership firms, consistent with the effect being driven by less-sophisticated investors. Furthermore, we find that it takes the market 30 to 60 days to correct for the distraction effect. Overall, we provide a unique test of the theory of limited attention by documenting that extraneous events can have a significant impact on the pricing of earnings.

Working Papers

Non-GAAP EPS Denominator Choices (SSRN), with Tom Linsmeier and Clay Partridge

We provide the first comprehensive evidence about firms’ non-GAAP EPS denominator choices. SEC guidance requires firms to report non-GAAP EPS “on a diluted basis”. 14 percent of non-GAAP EPS reporting firms adjust the GAAP diluted EPS denominator; 56 percent of loss converting firms (reporting GAAP loss and non-GAAP profit) adjust the GAAP denominator. Nearly all adjustments (1) increase the denominator by adding potential claims, (2) reduce non-GAAP EPS, and (3) increase non-GAAP EPS informativeness incrementally to that of numerator adjustments. Opportunism in denominator choices is concentrated in loss converting firms that fail to adjust the denominator and, instead, use the GAAP diluted EPS denominator which excludes all potential claims. In this instance, non-GAAP EPS is more likely to exceed the EPS number analysts consider appropriate. Overall, we find that nearly all adjusted denominators are informative and convey information about potential claims, which underscores the importance of such claims for investors.

Comparing Internal Views of Performance: ASC 280’s Management Approach and Non-GAAP Reporting (SSRN), with Michael Durney and Zac Wiebe

Accounting standard setters require firms to report segment performance based on how management evaluates segments when making internal resource allocation decisions (ASC 280’s Management Approach). Standard setters’ use of such an “internal view” assumes that the information management uses internally is always useful for external investors. We highlight an important limitation of this assumption by comparing segment profit/loss and non-GAAP earnings, a second performance measure frequently used for internal purposes such as contracting and evaluation. Using a sample of multi-segment firms that disclose non-GAAP earnings from 2003-2018, we find that non-GAAP earnings is more relevant than segment profit/loss measures for (1) predicting future cash flows and earnings, (2) valuing the entity, and (3) assessing stewardship. A controlled experiment involving 247 experienced managers suggests that the Management Approach inherently limits the relevance of segment performance measures because a measure designed for internal resource allocation is misaligned with what is useful for external investors.

A Firm-Quarter Measure of Non-GAAP Exclusion Persistence (SSRN), with Ken Li and Ben Whipple

Managers commonly justify non-GAAP reporting by claiming that their calculation of non-GAAP earnings excludes items that do not reflect core operations. However, the non-GAAP literature lacks a firm-quarter measure to identify which firms have non-GAAP exclusions that are consistent versus inconsistent with this justification. We create a firm-quarter measure that predicts how a firm’s non-GAAP exclusions will associate with future performance, an association we label as “exclusion persistence.” We find that our firm-quarter measure has significant predictive ability and is superior to existing measures of non-GAAP reporting quality in distinguishing firms based on actual exclusion persistence. We also highlight several unique applications of our measure, including: (1) finding settings where GAAP earnings is better than non-GAAP earnings at predicting future performance, (2) identifying characteristics that distinguish firms with high and low exclusion persistence, and (3) providing evidence that investors’ mispricing of non-GAAP exclusions varies with exclusion persistence.

Decision-Usefulness of Expected Credit Loss Information under CECL (SSRN), with Jed Neilson, Brent Schmidt, and Biqin Xie

The Financial Accounting Standards Board (FASB) recently replaced the “incurred loss” (IL) model of reporting credit losses with the “current expected credit loss” (CECL) model to improve the timeliness of credit loss information for financial statement users. CECL requires entities to recognize estimated lifetime credit losses upon loan origination, which is timelier than the IL model but potentially less accurate. We examine whether newly recognized credit losses under CECL (i.e., the CECL day-1 impact) are decision-useful for equity investors. We find that CECL day-1 impacts improve the value relevance of credit loss allowances and their predictive ability for future credit losses, and overall, that CECL allowances have greater value relevance and predictive ability than IL allowances. Furthermore, CECL day-1 impacts provide new information to investors, rather than only confirming expectations, which reduced investor uncertainty during the onset of the COVID-19 crisis.