The Relation Between Earnings Management and Non-GAAP Reporting

Posted: 3 May 2013 Last revised: 28 Jun 2019

See all articles by Ervin L. Black

Ervin L. Black

Steed School of Accounting

Theodore E. Christensen

University of Georgia - J.M. Tull School of Accounting; University of Georgia

T. Taylor Joo

New Mexico State University

Roy Schmardebeck

The University of Tennessee, Knoxville - Haslam College of Business, Accounting and Information Management

Date Written: November 6, 2016

Abstract

Managers have a variety of tools at their disposal to influence stakeholder perceptions. Earnings management and the strategic reporting of non‐GAAP earnings are just two of the available menu choices. We explore how real earnings management and accruals management influence the probability that a company will disclose a non‐GAAP adjusted earnings metric in its earnings press release and the likelihood that it will do so aggressively. We first investigate situations where managers already meet analysts’ expectations either based on strong operating performance or after employing real and accruals management. We find that when solid operating performance alone allows firms to meet expectations, managers do not employ earnings management or non‐GAAP reporting. However, when managers meet expectations using real and accruals management, they are significantly less likely to report a non‐GAAP earnings metric. Next, we explore scenarios where companies fall short of expectations. We find that when they just miss expectations after managing GAAP earnings, they are significantly more likely to employ non‐GAAP reporting, suggesting that the timing and relatively costless nature of non‐GAAP reporting allows managers to appear to meet expectations on a non‐GAAP basis when managed GAAP earnings fall short. Moreover, we find that companies are more likely to report non‐GAAP earnings (and to do so aggressively) when (i) they are unable to use real or accruals earnings management, (ii) are constrained by prior‐period accruals management, and (iii) their operating performance is poor. Taken together, our results are consistent with a substitute relation between non‐GAAP reporting and both real and accruals management.

Keywords: pro forma earnings, accruals, real earnings management, earnings management constraints

JEL Classification: G14, G18, M40, M41

Suggested Citation

Black, Ervin L. and Christensen, Theodore E. and Joo, T. Taylor and Schmardebeck, Roy, The Relation Between Earnings Management and Non-GAAP Reporting (November 6, 2016). Contemporary Accounting Research, Vol. 34, No. 2, 2017. Available at SSRN: https://ssrn.com/abstract=2259379 or http://dx.doi.org/10.2139/ssrn.2259379

Ervin L. Black

Steed School of Accounting ( email )

307 W Brooks
Norman, OK 73019
United States
405-325-2401 (Phone)

Theodore E. Christensen (Contact Author)

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States

University of Georgia ( email )

Athens, GA
United States

T. Taylor Joo

New Mexico State University ( email )

Departmment of Accounting and IS
MSC 3DH
Las Cruces, NM 88011
United States

Roy Schmardebeck

The University of Tennessee, Knoxville - Haslam College of Business, Accounting and Information Management ( email )

The Boyd Center for Business and Economic Research
Knoxville, TN 37996
United States

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