Litigation Risk and Non-GAAP Reporting
55 Pages Posted: 7 Mar 2017
Date Written: February 2017
Non-GAAP earnings disclosures are widely used by investors and analysts. Yet, for nearly two decades, an ongoing debate in the financial press and the academic literature has centered on whether non-GAAP earnings metrics portray primarily informative or overly optimistic performance assessments. While researchers have attempted to understand the motives behind these non-standard performance metrics, more specific evidence on the influence of market monitoring mechanisms on non-GAAP reporting can help inform this discussion. We provide the first rigorous examination of the association between litigation risk and non-GAAP reporting. Specifically, we use a quasi-natural-experimental setting in which U.S. federal appeals court rulings result in significant changes in litigation risk and employ a difference-in-differences design to explore how these circuit-specific shocks influence firms’ propensity to provide non-GAAP performance metrics. We find that firms increase (decrease) their non-GAAP reporting activity when litigation risk decreases (increases). We also provide evidence that differences in non-GAAP reporting across circuits diminished after Reg G, suggesting that this regulation reduced litigation risk by creating a safe harbor for non-GAAP disclosure. We conclude by providing evidence regarding how our litigation risk shocks relate to other empirical litigation risk measures to inform future research examining or controlling for litigation risk.
Keywords: Non-GAAP Disclosure, Litigation Risk, Regulation
JEL Classification: M48, M41
Suggested Citation: Suggested Citation