Non-GAAP Reporting and Investment
80 Pages Posted: 20 Dec 2019 Last revised: 23 May 2022
Date Written: May 23, 2022
When investors use GAAP earnings to value firms’ shares, managers’ investments into intangible assets become sensitive to transitory earnings. Non-GAAP earnings can remove these transitory earnings, and thus improve investment efficiency, but also introduce opportunistic bias, and thus hide inefficient investment. We quantify this trade-off by estimating a dynamic model in which a manager makes investment and non-GAAP disclosure decisions. We find the manager’s ability to bias non-GAAP earnings creates inefficient investment choices and destroys firm value. We estimate the magnitude of overinvestment at 6% and the corresponding loss in the average firm value at just under 1%.
Keywords: Non-GAAP; pro-forma; investment; intangible assets; real effects; structural estimation
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