Litigation Risk and the Regulation of Non-GAAP Reporting

48 Pages Posted: 7 Mar 2017 Last revised: 9 Oct 2019

See all articles by Richard A. Cazier

Richard A. Cazier

University of North Texas

Theodore E. Christensen

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

Kenneth J. Merkley

Indiana University - Kelley School of Business - Department of Accounting

John Treu

West Virginia University - College of Business & Economics

Date Written: February 1, 2017

Abstract

The SEC has recently raised renewed concerns about firms’ reporting of adjusted (non-GAAP) earnings metrics. Regulators have significant interest in understanding the factors that help constrain non-GAAP reporting. We first provide evidence on the relation between securities litigation risk and firms’ propensity to report non-GAAP earnings. We then provide evidence on how this relation is moderated by the regulation of non-GAAP disclosure under Reg G. Using a plausibly exogenous litigation shock based on a U.S. circuit court ruling, we find a robust negative relation between litigation risk and non-GAAP reporting prior to the passage of Reg G. This negative relation suggests that, in the absence of rules-based regulation of non-GAAP reporting, litigation risk helps to constrain non-GAAP disclosure. However, our evidence suggests that the subsequent regulation of non-GAAP disclosure has decreased the sensitivity of non-GAAP disclosure to litigation risk. Specifically, we find that differences in non-GAAP reporting across judicial circuits are diminished and the negative association between litigation risk and non-GAAP reporting is significantly attenuated following the implementation of Reg G. Our results are consistent with claims that Reg G has had the unintended consequence of shielding firms’ non-GAAP disclosures from litigation risk by creating a de facto “safe harbor” for non-GAAP disclosure. Finally, we use our quasi-natural-experimental setting to validate a new proxy for circuit-specific litigation risk that future researchers can employ in any setting.

Keywords: Non-GAAP Disclosure, Litigation Risk, Regulation

JEL Classification: M48, M41

Suggested Citation

Cazier, Richard A. and Christensen, Theodore E. and Merkley, Kenneth J. and Treu, John, Litigation Risk and the Regulation of Non-GAAP Reporting (February 1, 2017). Available at SSRN: https://ssrn.com/abstract=2928260 or http://dx.doi.org/10.2139/ssrn.2928260

Richard A. Cazier (Contact Author)

University of North Texas ( email )

College of Business Administration
P.O. Box 305219
Denton, TX 76203
United States
940-369-8612 (Phone)

Theodore E. Christensen

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

Athens, GA 30602
United States

University of Georgia ( email )

Athens, GA
United States

Kenneth J. Merkley

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

John Treu

West Virginia University - College of Business & Economics ( email )

P.O. Box 6025
Morgantown, WV 26506
United States

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