Non-GAAP Earnings Disclosure and the Valuation of IPOs

Abstract

We investigate the disclosure of non-GAAP earnings metrics in IPO prospectuses and how these disclosures affect IPO valuation. While the likelihood of non-GAAP reporting has continued to increase among public firms, we find an initial increase, but later a decline in the disclosure of non-GAAP performance metrics among IPO firms in recent years, suggesting that SEC scrutiny of non-GAAP reporting has caused some managers to think twice about their disclosure. Our valuation tests indicate that IPO firms disclosing non-GAAP earnings metrics generally exhibit higher offer values and less undervaluation during the IPO process. We also find that adjusted earnings information is value-relevant and associated with higher IPO valuations. Our evidence indicates that the earnings exclusions made by IPO firms are appropriately weighted by investors during and after the IPO process. A detailed analysis of issuers’ earnings exclusions reveals that IPOs exhibit higher valuations when prospectuses contain non-GAAP metrics that adjust for routine recurring expenses as well as uncommon non-recurring items. We however find that add-backs to revenue (which are less justifiable according to regulatory views) are negatively weighted by investors on the first day of trading. Additional analyses suggest that IPO valuations are lower across all stages of the pricing process for non-GAAP IPOs that elect to file reduced disclosures as an emerging growth company under the 2012 JOBS Act. Nonetheless, we find that non-GAAP earnings exclusions can help to mitigate undervaluation for emerging growth issuers that are more informationally opaque.

Keywords: non-GAAP, IPOs, prospectus, disclosure

JEL Classification: D84, G14, M41