The Great Unknown: Why Exclude “Other” Items from Non-GAAP Earnings Calculations in the Post-Reg G World?

Abstract

The underlying motives for non-GAAP earnings disclosures have garnered a great deal of research in the extant literature, which is important given that non-GAAP reporting is at an all-time high. In examining these motives, the non-GAAP literature groups managers’ and analysts’ earnings adjustments into two categories: (1) special item exclusions and (2) other item exclusions. Special item exclusions relate to one-time items and non-GAAP studies find that excluding these items from non-GAAP earnings calculations is largely informative. In contrast, other item exclusions frequently relate to recurring earnings components (e.g., amortization expense), are currently the most common form of non-GAAP adjustment (78% of non-GAAP firms exclude other items), and early studies find that excluding these items is generally opportunistic. More recent studies provide evidence suggesting that SEC regulations have lessened the opportunism in other exclusions, but do not provide insight into which incentives currently motivate these common adjustments, which is the purpose of my study. I find that excluding other items in the current reporting environment is largely informative because these exclusions relate to non-cash items that are heavily discounted by investors when pricing firm performance. In addition, excluding other items creates earnings metrics that are comparable to analysts’ ex ante earnings forecasts, which provides investors with comparable ex ante and ex post assessments of performance. Thus, although I find some evidence that opportunism can still motivate other item exclusions in certain scenarios, the primary motives for these adjustments in the current reporting environment appear to be informative in nature.

Keywords: Non-GAAP earnings; Street earnings; Non-GAAP exclusions; Other exclusions; Recurring item exclusions

JEL Classification: M41