The effect of voluntary clawback adoption on non-GAAP reporting

We examine the effect of voluntary adoption of clawback provisions on non-GAAP earnings disclosures. Prior literature documents that voluntary clawback adoption improves financial reporting quality by increasing the costs of misstating GAAP earnings. However, managers may respond to perceptions of reduced discretion over GAAP reporting by increasing their reliance on non-GAAP earnings disclosures. Using a propensity score matched sample, we find that non-GAAP earnings disclosure frequency increases and non-GAAP exclusion quality decreases after clawback adoption, consistent with a more opportunistic use of non-GAAP reporting. Additional cross-sectional tests help support this interpretation.     

Post-regulation G findings

Researchers generally recognize that the stated goal of Regulation G (Reg. G), the Securities and Exchange Commission’s (SEC) conditions for use of non-Generally Accepted Accounting Principles (GAAP) financial measures, is to improve the quality and transparency of non-GAAP financial measures rather than to specifically affect various reporting trends of such measures. Various researchers continue to report substantial deceases in the number of non-GAAP disclosures and/or discloser firms since its implementation in early 2003. By using a sampling criteria in line with the SEC’s definition of non-GAAP financial measures and by reviewing actual corporate press releases, rather than relying on proxies (such as keyword searches), our results indicate that the proportion of companies releasing non-GAAP financial measures has decreased only moderately. We further examine recent changes in two areas of reporting trends noted in prior literature and conclude: (1) the most common pre-Reg. G categories of adjustments have changed and non-GAAP terminology remains as inconsistent as noted in pre-Reg. G research; and (2) the business services sector, which had previously been identified as a prominent non-GAAP discloser (reporting) sector is still an avid discloser of non-GAAP financial measures.     

Non-GAAP earnings disclosures around regulation G – The case of “implicit non-GAAP reporting”

We identify a phenomenon related to non-GAAP earnings disclosure and examine its prevalence around Regulation G (RegG). Specifically, we analyze to what extent firms only disclose adjustments to GAAP earnings instead of entire adjusted earnings figures thereby not providing the ideal non-GAAP to GAAP reconciliation promoted by RegG. We refer to this reporting behavior as “implicit non-GAAP reporting” and ask three different questions: How is “implicit non-GAAP reporting” related with the adoption of RegG? What type of firm reports implicit non-GAAP measures? What are the motives for “implicit non-GAAP reporting” post-RegG? Our analyses yield three key findings. First, the frequency of “implicit non-GAAP reporting” spikes after the regulatory intervention but to a lesser degree also existed before. Second, during the post-RegG time period, the prevalence of “implicit non-GAAP reporting” is much higher among firms who only started to report non-GAAP earnings after RegG was enacted (starters) than among those, which continued to disclose non-GAAP earnings across the regulatory intervention (continuers). Third, we show that only for starters, “implicit non-GAAP reporting” is associated with motives of beating analyst earnings forecasts as well as experiencing GAAP losses. Our study provides important insights for regulators, firms and academics into "implicit non-GAAP reporting" by examining properties and determinants of implicit vs. explicit non-GAAP earnings for different types of firms around RegG.     

The Effects of Compensation and Board Quality on Non-GAAP Disclosures in Europe

This study reports international evidence on the impact of compensation and board quality on the voluntary disclosure of non-GAAP earnings numbers. We find that compensation contracts of board directors that are linked to firm's market performance are associated with a higher probability of disclosure of non-GAAP figures in the earnings announcements' press release. Furthermore, when this type of compensation is used, firms tend to report non-GAAP figures in the title of the press release, make more adjustments for recurring items, and avoid reporting reconciliations. These reporting practices have been associated with opportunistic disclosure. We also show that an efficient governance structure of the board of directors can help restrain most of these discretionary disclosure decisions regarding non-GAAP reporting.     

SEC interventions and the frequency and usefulness of non-GAAP financial measures

This paper examines the effect of two Securities and Exchange Commission regulatory interventions related to disclosure of non-GAAP financial measures. There are three main results. First, the probability of disclosure of non-GAAP earnings declines in 2003, but the probability of disclosure of other non-GAAP financial measures has an accelerated decline after the first intervention. Second, all else equal, after Regulation G, investors have a positive market reaction to the disclosure of non-GAAP earnings. Finally, investors react to the adjustments made by I/B/E/S financial analysts as they do to the GAAP surprise, but they do not react to the additional adjustments made by firms.     

Local political corruption and Firm's non-GAAP reporting

We examine whether local political corruption affects managers' discretionary disclosures of non-GAAP earnings. Using United States Department of Justice data on the number of corruption convictions of government officials, we find that firms headquartered in more corrupt districts (1) are less likely to report non-GAAP earnings, (2) have less aggressive non-GAAP earnings disclosures, and (3) experience a significant decline in the exclusion magnitudes of non-GAAP earnings. These results are more pronounced for firms with concentrated operations in their headquarter states and are robust to controlling for demographic characteristics, employing alternative corruption and non-GAAP measures, using the instrumental variable approach, and conducting a difference-in-difference analysis based on firms' relocation. Finally, we show that as local political corruption increases, managers exclude lower levels of both recurring and non-recurring items when calculating non-GAAP earnings. Overall, the results suggest that managing non-GAAP reporting is one channel through which firms could deter rent-seeking by corrupt officials.     

Non-GAAP earnings reporting following going-concern opinions

We examine non-GAAP earnings reporting following a going-concern audit opinion (GCO). Using a propensity score-matched sample, matching first-time going-concern issuing companies with firms in financial distress that did not receive a going-concern report, we find that the likelihood and frequency of non-GAAP earnings reporting are lower following GCOs. In additional analyses, we find the negative association between the announcement of GCOs and the likelihood and frequency of non-GAAP earnings reporting stronger when GCOs are issued by industry-specialist auditors and when GCOs are unexpected, but do not find litigation risk or managers' ability to affect the association. These results are consistent with a decrease in investor demand for non-GAAP earnings disclosures following GCOs.     

Managerial risk-taking incentives and non-GAAP earnings disclosures

We investigate the association between risk-taking incentives provided by stock-based compensation arrangements and non-GAAP financial disclosures. Controlling for compensation to stock price sensitivity, we find that managers with higher compensation to stock volatility sensitivity (vega) are more likely to be associated with voluntary non-GAAP earnings information disclosures. In addition, higher-vega managers are found to be associated with more frequent and less opportunistic non-GAAP earnings information disclosures. Robust to alternative specifications and estimations, our findings suggest that compensation arrangements can encourage managers to make more, higher-quality voluntary non-GAAP disclosures.     

Pro forma disclosures,audit fees,and auditor resignations

The disclosure of non-GAAP (pro forma) earnings numbers by managers in the post-SOX era continues to attract attention from regulators, media, and researchers. However, there is limited empirical evidence on how auditors view clients that emphasize pro forma earnings over GAAP earnings. We study the extent to which audit fees and auditor resignations are associated with opportunistic non-GAAP disclosures. We find that during the pre-SOX period, optimistic pro forma differences, measured using either IBES actual earnings or hand-collected pro forma earnings, are associated with higher audit fees and a higher likelihood of auditor resignations. Additional results indicate that auditors seem to be more concerned with non-GAAP earnings disclosures in the post-SOX period.     

Pro forma accounting disclosures: The effect of reconciliations and financial reporting knowledge on nonprofessional investors' judgments

Regulation G requires companies that report non-GAAP or “pro forma” earnings provide a reconciliation. While nonprofessional investors are a large, heterogeneous population with varying degrees of financial reporting knowledge, previous research treats them as a homogenous group. The study examines how differences in financial reporting knowledge and information viewing behavior affect the influence of reconciled pro forma earnings disclosures on nonprofessional investors' judgments. Lower-knowledge investors appear to incorporate information on differences between GAAP and pro forma earnings in their judgments as long as they view this information in the reconciliation. However, higher-knowledge investors appear to consistently incorporate information on differences between GAAP and pro forma earnings in their judgments regardless of the relative amount of time they spend viewing the reconciliation relative to other disclosures. Our results suggest that knowledge differences influence how nonprofessional investors acquire and use information on differences between GAAP and pro forma earnings.     

Disclosure strategies among S&P 500 firms: Evidence on the disclosure of non-GAAP financial measures and financial statements in earnings press releases

This paper examines the prominence of non-GAAP financial measures in press releases, testing whether managers emphasize these adjusted performance measures relative to GAAP numbers in four different settings where their disclosure helps managers reach strategic earnings benchmarks on a pro forma basis when they would otherwise fall short using GAAP numbers. Moreover, this research investigates the information content of disclosures reconciling non-GAAP to GAAP earnings (and other financial statements). The data is hand collected from quarterly earnings press releases of a sample of S&P 500 firms during the 2001–2003 period. In this particular sample, the disclosure of non-GAAP financial measures is frequent. The results suggest that managers strategically give more prominence to non-GAAP measures than to GAAP figures when the GAAP earnings number falls short of a benchmark but the non-GAAP earnings number does not. This disclosure strategy may influence the perception of the firm's financial results. Furthermore, the results suggest that both the reconciliation and the non-GAAP income statement contain information useful for users.     

The effect of disclosure committees on non-GAAP reporting quality

I examine whether company-implemented disclosure committees help to improve non-GAAP reporting quality. I find that firms with disclosure committees provide higher quality non-GAAP performance metrics and that the exclusions used to calculate their non-GAAP numbers are less persistent for future operating income and operating cash flows. Moreover, I find that firms with disclosure committees are less likely to receive SEC comment letters about non-GAAP disclosure. For firms that receive comment letters about non-GAAP reporting, disclosure committees can help to improve non-GAAP reporting quality. Comparing the influence of audit committees and disclosure committees, I find that audit committee financial experts have stronger monitoring effects than those on disclosure committees. Meanwhile, legal experts on disclosure committees provide similar monitoring compared to audit committees’ financial experts. Finally, the interaction between audit committee financial experts and disclosure committee legal experts produces the strongest effect on non-GAAP reporting quality. In sum, my analyses suggest that disclosure committees can provide important monitoring of non-GAAP reporting.     

Improving the relevance of risk factor disclosure in corporate annual reports

This research develops a model for assessing the quality of risk disclosures and applies the proposed model to four companies in the food production and processing sector. We contribute to the literature by extending prior work on risk disclosure quality using a longitudinal approach to assess the quality of risk reporting. While previous studies have described disclosure practices, this paper adopts a normative approach to disclosure. By suggesting a way of improving risk reporting disclosures, the paper provides guidance for current and future company managers. In line with previous research, this paper identifies certain problems with existing risk disclosures. Results suggest that company managers prefer providing disclosures that are symbolic rather than substantive. We argue that institutional factors and proprietary costs contribute towards and can explain this behaviour. In suggesting a way forward we highlight the role that stakeholders including managers, users, regulators and auditors can play in improving the quality of risk reporting. Flexibility in reporting could be maintained by adopting a properly monitored ‘comply or explain’ approach.     

The usefulness of firm risk disclosures under different firm riskiness,investor-interest,and market conditions: New evidence from Finland

To date, there is only meager research evidence on the usefulness of mandatory annual report risk disclosures to investors. Although it has been argued that corporate disclosure decreases information asymmetry between management and shareholders, we do not know whether investors benefit from high-quality risk reporting in a highly regulated risk disclosure environment. In this paper, we performed association tests to examine whether the quality of firms' mandatory risk disclosures relate to information asymmetry in the Finnish stock markets. In addition, we analyzed whether the usefulness of risk disclosures depends on contingency factors such as firm riskiness, investor interest, and market condition. We demonstrate that the quality of risk disclosure has a direct negative influence on information asymmetry. We also document that risk disclosures are more useful if they are provided by small firms, high tech firms, and firms with low analyst coverage. We also found that momentum in stock markets affects the relevance of firms' risk reports.     

Non-GAAP earnings and board independence

We examine the association between board independence and the characteristics of non-GAAP earnings. Our results suggest that companies with less independent boards are more likely to opportunistically exclude recurring items from non-GAAP earnings. Specifically, we find that exclusions from non-GAAP earnings have a greater association with future GAAP earnings and operating earnings when boards contain proportionally fewer independent directors. Consistent with the association between board independence and the permanence of non-GAAP exclusions reflecting opportunism rather than the economics of the firm, we find that the association declines following Regulation G and that managers appear to use exclusions to meet earnings targets prior to selling their shares more often in firms with fewer independent board members. Overall, our results suggest that board independence is positively associated with the quality of non-GAAP earnings.     

Discretionary compliance with mandatory environmental disclosures: Evidence from SEC filings

We examine the determinants of adherence to U.S. Securities and Exchange Commission (SEC) mandated disclosures of environmental sanctions. Our sample includes non-superfund U.S. Environmental Protection Agency (EPA) sanctions between 1996 and 2005. Our results suggest that firms are more likely to provide sanction disclosures if they operate in environmentally sensitive industries, are subject to larger penalties and are voluntarily participating in a supplemental environmental project. Our results also suggest that firms are less likely to disclose sanctions involving judicial proceedings. Overall, we find that voluntary disclosure incentives impact compliance with mandatory reporting requirements. Although incentives exist for firms to comply with mandatory disclosures, our results suggest that increases in mandatory environmental accounting disclosures may not be effective under the current regulatory system despite the use of bright-line materiality thresholds. Our study contributes to the current and ongoing debate about the role and effectiveness of environmental risk disclosure mandates in providing information to the marketplace, as well as “mandated disclosure” rules in general. The value attributed to current and potential environmental disclosure regulations cannot be thoroughly understood without examining disclosure compliance with existing regulations. From an environmental and sustainability disclosure perspective, our findings are particularly germane since these disclosures focus on risks, liabilities, or other reputational shortcomings of the firm.     

Corporate Disclosure Quality: Lessons from Australian Companies on the Impact of Adopting International Financial Reporting Standards

For annual reporting periods beginning on or after 1 January 2005, Australian companies were required to comply with the Australian equivalents of International Financial Reporting Standards (AIFRS). To ensure a smooth transition, a broadly defined standard (AASB 1047) mandated pre-adoption company disclosures of the AIFRS' impact. The standard provided managers with the opportunity to exercise considerable discretion in complying with the underlying disclosure requirements. We examine how this discretion impacted on the quality of pre-adoption AIFRS disclosures provided by a sample of large Australian companies. Using a disclosure quality index, we find considerable evidence of a cross-sectional variation in disclosure quality that varies according to differences in the AIFRS financial impact, size, industry and profitability factors. Importantly, we also observe individual Big 4 audit firm influences on disclosure quality. These findings highlight consequences of mandating corporate disclosures based on broadly defined principles.     

Non-GAAP Earnings Disclosures on the Face of the Income Statement by UK Firms: The Effect on Market Liquidity

This study benefits by a special feature of the UK information environment which allows UK firms to disclose non-GAAP earnings on the face of the income statement to examine two interrelated questions. First, we ask whether the decision to disclose non-GAAP earnings on the face of the income statement is related to the firm's financial performance and corporate governance characteristics, and second, we investigate the effect of this disclosure decision on market liquidity. Using a dataset of 1227 hand-collected firm-year observations during the period 2006–2013, we show that better governed firms and firms with weaker financial performance are more likely to disclose non-GAAP earnings. Our evidence also suggests that this disclosure is associated with increased levels of market liquidity and the results hold after controlling for self-selection bias. We conclude that firms' decision to disclose non-GAAP earnings on the face of the income statement is more consistent with the incentive to provide information than to mislead the market.     

Stock price crash risk and internal control weakness: presence vs. disclosure effect

This study examines the stock price crash risk for a sample of firms that disclosed internal control weaknesses (ICW) under Section 404 of the Sarbanes‐Oxley Act (SOX). We find that in the year prior to the initial disclosures, ICW firms are more crash‐prone than firms with effective internal controls. This positive relation is more pronounced when weakness problems are associated with a firm's financial reporting process. More importantly, we find that stock price crash risk reduces significantly after the disclosures of ICWs, despite the disclosure itself signalling bad news. The above results hold after controlling for various firm‐specific determinants of crash risk and ICWs. Using an ICW disclosure as a natural experiment, our study attempts to isolate the presence effect of undisclosed ICWs from the initial disclosure effect of internal control weakness on stock price crash risk. In so doing, we provide more direct evidence on the causal relation between the quality of financial reporting and stock price crash risk.