Are Investors Misled by Exclusions of Recurring Expenses from Non-GAAP Earnings?

121 Pages Posted: 8 Jul 2019 Last revised: 2 Mar 2020

See all articles by Oliver Mehring

Oliver Mehring

Paderborn University

Jens Mueller

Paderborn University

Soenke Sievers

Paderborn University

Christian Sofilkanitsch

Paderborn University

Date Written: February 20, 2020

Abstract

While non-GAAP reporting is under debate as managers might opportunistically inflate non-GAAP earnings, analytical research by Hirshleifer and Teoh (2003) proposes that limited attention causes mispricing when inappropriate items are excluded from non-GAAP earnings but will be reversed subsequently. Addressing this proposition empirically, we find that market revisions upon the release of material restatements (a proxy of heightened investor attention) are more negative for firms that ex-ante excluded recurring expenses frequently (a proxy for inappropriate non-GAAP adjustments). This finding suggests that investors may fail to detect less salient, yet available, public information. Further, we document that investors reward aggressively reported non-GAAP earnings before the restatement announcement, but punish the same reporting choices in the post-restatement period. Overall, our findings suggest that investor attention, which increases after the restatement, enhances investors’ ability to disentangle aggressive from non-aggressive non-GAAP reporting choices. Findings hold for the pre- and post-Regulation G period.

Keywords: Non-GAAP reporting, investor attention, financial restatements, information content of earnings, firm value, overvaluation

JEL Classification: G1, K4, M4

Suggested Citation

Mehring, Oliver and Mueller, Jens and Sievers, Soenke and Sofilkanitsch, Christian, Are Investors Misled by Exclusions of Recurring Expenses from Non-GAAP Earnings? (February 20, 2020). Available at SSRN: https://ssrn.com/abstract=3415109 or http://dx.doi.org/10.2139/ssrn.3415109

Oliver Mehring

Paderborn University ( email )

Warburger Str. 100
Paderborn, 33098
Germany

Jens Mueller

Paderborn University ( email )

Warburger Str. 100
Paderborn, 33098
Germany

Soenke Sievers

Paderborn University ( email )

Warburger Str. 100
Paderborn, 33098
Germany

HOME PAGE: http://www.upb.de/accounting

Christian Sofilkanitsch (Contact Author)

Paderborn University ( email )

Warburger Str. 100
Paderborn, 33098
Germany

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