The Value Relevance of a Non-GAAP Performance Metric to the Capital Markets

Abstract:     
Our paper explores whether reducing management discretion in the reporting of performance is value relevant to capital markets. The study is driven by concerns raised by standard setters and others about the usefulness of performance reporting under Generally Accepted Accounting Principles (GAAP). Of primary interest is whether explicitly defining what information should be included in earnings results in an earnings measure that is more relevant than operating earnings computed according to current GAAP. The value relevance of this non-GAAP earnings measure is examined by estimating market valuation and returns models for 518 U.S. firms included in the Standard & Poor's 500 index over the time period 2002-2004. Results show that the explicitly defined non-GAAP measure used is significantly associated with equity market values and returns and is significantly more value relevant than the GAAP measure. Our paper contributes to accounting literature assessing the relevance of earnings in setting equity market value. More specifically, we provide evidence consistent with prior results that non-GAAP performance measures are more useful in valuation than GAAP earnings. However, in contrast to prior studies, the more explicit performance measure we examine removes some of the classificatory discretion pervasive in other non-GAAP earnings metrics. Our study also informs standard setters who are considering whether adjustments to current financial reports can increase their relevance to capital markets.

Keywords: Earnings informativeness, Core earnings, GAAP earnings, Analyst earnings

JEL Classification: G12, G14, M41, M43, M44

Accepted Paper Series