Non-GAAP Earnings and Stock Price Crash Risk

Abstract

Prior research concludes that stock price crash risk is primarily attributable to managers’ withholding of bad news from investors. We extend this literature by investigating whether crash risk can also occur when managers disclose additional information via non-GAAP reporting, which downplays reported bad news by re-directing investors’ attention to other, more positive aspects of performance. We find that the likelihood of crash risk is higher when managers have reported non-GAAP earnings more frequently during the past year. We also find that managers appear to use non-GAAP reporting as a substitute for the more common reason for crash risk in prior research–withholding bad news. Moreover, we find that the association between non-GAAP disclosure and crash risk increases in periods when managers are likely more aggressive in their non-GAAP reporting. Finally, we use a regulatory shock as a quasi-natural experiment to mitigate endogeneity concerns.

Keywords: Non-GAAP earnings, Stock price crash risk, Disclosure, Regulation

JEL Classification: D82, G12, G17, G18, M41