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Non-GAAP Reporting: A Comparability Crisis

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Non-GAAP Reporting: A Comparability Crisis

Dirk E. Black

Tuck School of Business at Dartmouth

Theodore E. Christensen

University of Georgia


Jack T. Ciesielski Jr.

R.G. Associates

Benjamin C. Whipple

University of Georgia – C. Herman and Mary Virginia Terry College of Business

April 4, 2016


The IASB and the FASB have both expressed interest in the recent proliferation of non-GAAP reporting, raising questions about what this increasing reporting trend means for IFRS- and GAAP- based reporting. Our goal is (1) to inform standard setters on the current state of non-GAAP reporting and (2) explore how the discretion afforded in non-GAAP reporting influences earnings consistency and comparability, two tenets of IFRS- and GAAP-based earnings. We begin by providing an up-to-date discussion of the most common questions examined in the extant literature to provide insights on what academics have learned about non-GAAP reporting. Next, we utilize a novel dataset of detailed non-GAAP disclosures to provide in-depth descriptive evidence on the current state of non-GAAP reporting. We find that the frequency of non-GAAP reporting has increased by 35% in recent years, a trend that we find in every sector. We also provide evidence on how the frequency and magnitude of specific exclusions has changed over time. Of particular interest is the increasing frequency in which firms exclude items that are not commonly excluded by other firms, indicating that more idiosyncratic definitions of non-GAAP earnings are emerging in the marketplace. Finally, we examine how the discretion in non-GAAP reporting affects earnings consistency and comparability. We find that the consistency with which firms calculate non-GAAP metrics varies by sector and is generally increasing across time, with the exception of how firms exclude recurring items (which is becoming more inconsistent). We also find some evidence that inconsistent recurring item adjustments are associated with lower quality non-GAAP metrics, while inconsistent nonrecurring adjustments are associated with higher quality metrics. In examining comparability, we find descriptive evidence indicating that within-sector performance rankings based on GAAP earnings better explains concurrent stock returns than comparisons based on non-GAAP earnings. However, these differences are not statistically significant in our empirical analyses.

Non-GAAP Reporting: A Comparability Crisis – Introduction

The proliferation of non-GAAP reporting over the past two decades has led many investors to embrace non-standard performance metrics as an important way to evaluate a firm’s trajectory. Although skeptics have frequently viewed non-GAAP disclosure as a threat to the traditional GAAP-based income statement, standard setters have recognized that non-GAAP metrics can be informative to investors and have laid the groundwork for firms to disclose more disaggregated earnings information to facilitate investors’ ability to interpret “non-standard” earnings metrics. Despite regulatory requirements for transparency in non-GAAP reporting, there are currently no regulations or accounting standards requiring across-time consistency for a given firm or across-firm comparability within an industry or sector in non-GAAP reporting.1 Obviously, the term “non-GAAP” denotes that these performance metrics are “customized” and open to provider judgment. However, the very notion of reporting non-standard performance measures deviates from the “enhancing qualities” of comparability and consistency found in GAAP-based earnings (SFAC No. 8, FASB 2010). As a result, there is some concern that the increasing focus on non-GAAP metrics will lead to a financial reporting comparability crisis (Ciesielski 2015). In addition, standard setters and regulators have become more interested in non-GAAP reporting as the reporting practice has increased in frequency. However, the extant literature contains very little descriptive data on the current non-GAAP reporting environment for regulators and standard setters to consider.

This paper has three objectives. First, we summarize the academic literature on non-GAAP reporting to provide context on what we have learned so far and what remains unknown in the academic community with respect to non-GAAP reporting. Second, we provide up-to-date descriptive evidence about the current state of non-GAAP reporting using a new dataset that is considerably more granular than data sources used in prior studies. As a result, we inform regulators, standard setters, practitioners, and academics about which exclusion types and firm sectors have led to the recent proliferation in non-GAAP reporting. Finally, we shed light on how the consistency and comparability of managerdisclosed performance metrics influences non-GAAP reporting quality, which is a topic of interest to regulators, standard setters, and practitioners which has received surprisingly little attention in the extant literature.

For over 20 years, regulators and standard setters have expressed concerns about, and interest in, non-GAAP disclosure. In the early days of non-GAAP reporting (i.e., mid-1990s to early 2000s), these alternative metrics were generally less common, opaque, clustered in certain industries, and unregulated. As a result, regulators frequently expressed skepticism regarding the motives behind non-GAAP disclosures, which led the SEC to caution financial statement users about the potentially misleading nature of non-GAAP metrics (Dow Jones 2001; SEC 2001a; 2001b). When the U.S. Congress enacted the Sarbanes-Oxley Act (SOX) in 2002, legislators included a specific provision to address the problem of potentially misleading non-GAAP disclosures. As directed by SOX, the SEC implemented Regulation G (hereinafter Reg G) in March of 2003 to regulate firms’ use of non-GAAP disclosures, requiring non-GAAP reporting firms to reconcile their non-GAAP metrics to the most directly comparable GAAP-based metric. Numerous studies provide evidence that this regulation has improved the transparency and overall quality of non-GAAP reporting (e.g., Kolev et al. 2008; Heflin and Hsu 2008; Black et al. 2016b).

After an initial reduction in non-GAAP reporting following Reg G, the frequency of non-GAAP reporting has rebounded and is now at an all-time high. For example, Bentley et al. (2016) report that non-GAAP metrics are now available for approximately 60% of all firms. Although the regulation of non-GAAP reporting has remained largely unchanged since the implementation of Reg G, the SEC renewed its emphasis on non-GAAP financial measures by issuing a Compliance and Disclosure Interpretation on the topic in January of 2010 (updated in July of 2011). More recently, the SEC’s Enforcement Division labeled non-GAAP performance metrics a “fraud risk factor” (Leone 2010), and formed a taskforce in July of 2013 to scrutinize companies’ non-GAAP earnings metrics that could potentially be misleading (Rapoport 2013).

Non-GAAP Reporting

Moreover, the recent proliferation of non-GAAP metrics has re-kindled standard setters’ interest in the practice. In particular, the FASB undertook the “Financial Performance Reporting” project in 2014 and is currently debating whether the prominence of non-GAAP metrics indicates a need to better organize the income statement (Siegel 2014; Linsmeier 2015). For example, FASB board member Thomas Linsmeier notes that re-organizing the income statement to include more disaggregated sub-totals might better serve the needs of financial statement users both in calculating their own adjusted performance metrics and in better understanding non-GAAP disclosures provided by managers. In addition, the IASB’s Disclosure Initiative is now considering what the increasing frequency of non-GAAP reporting means for IFRS. The chairman of the IASB, Hans Hoogervorst, recently noted that the IASB is “open to the idea of learning from the use of non-GAAP measures,” particularly where the use of these metrics is common, and that these metrics might indicate a vacuum in IFRS for the IASB to consider. Hoogervorst, also noted, however, that IFRS should be the main measure of financial performance, because the measure is “neutral, comparable, and verifiable,” and that investors would benefit from more discipline in non-GAAP reporting (Hoogervorst 2015).

Non-GAAP Reporting

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