Why Do Large Positive Non-GAAP Earnings Adjustments Predict Abnormally High CEO Pay?

Abstract

CEOs of S&P 500 firms that report high non-GAAP earnings relative to GAAP earnings receive substantial unexplained pay. Crucially, this result remains even after controlling for the level of non-GAAP and GAAP earnings. These firms are relatively poor performers (i.e., low GAAP earnings and stock returns) and have less powerful CEOs, consistent with non-GAAP earnings being used as justification when high executive pay is more likely to cause outrage. Additionally, despite the lower GAAP and return performance, these firms are more likely to beat the earnings targets specified in their compensation plans, which likely increases investors’ perceptions of core operating earnings and reduces outrage. Indeed, these firms face less dissent from shareholders and proxy advisors, and no additional media scrutiny. Our evidence suggests that the fraction of CEO pay that seems attributable to opportunistic non-GAAP reporting, while limited, is economically meaningful.

Keywords: Non-GAAP earnings, CEO pay, performance evaluation, corporate governance

JEL Classification: G14, G34, G38, M12, M41