The Relationship between Non-GAAP Earnings and Aggressive Estimates in Reported GAAP Numbers

Abstract

This study uses a controlled experiment to examine the trade-off between managers’ use of non-GAAP and GAAP earnings to satisfy market expectations, and how this relationship can be moderated by both formal and informal regulatory attention to non-GAAP earnings. Our key takeaway is that allowing financial reporting discretion in an alternative disclosure channel, i.e. non-GAAP earnings, can reduce firms’ opportunistic GAAP reporting. However, statements by regulators about increased attention to non-GAAP earnings constrains this channel, and this can result in more aggressive GAAP earnings management and reduced GAAP earnings quality. We triangulate these findings with a survey and archival analyses, and find results that are consistent with this primary message. Our study provides evidence relevant to standard setters and regulators that non-GAAP measures may serve an important role even if they can be used opportunistically.

Keywords: Non-GAAP measures, earnings management, aggressive reporting, reconciliation

JEL Classification: G32; G41; H32; K22; M40; M41