A Firm-Quarter Measure of Non-GAAP Exclusion Persistence
55 Pages Posted: 13 Apr 2021
Date Written: April 13, 2021
The non-GAAP literature lacks a firm-quarter measure for evaluating managers’ common justification for non-GAAP reporting – that non-GAAP earnings excludes items unrelated to core operations. Without such a measure, it is difficult to identify which firms have non-GAAP exclusions that are consistent versus inconsistent with this justification. Using a machine learning approach, we create a firm-quarter measure that predicts how a firm’s non-GAAP exclusions will associate with future performance, an association we label as “exclusion persistence.” We find that our firm-quarter measure has significant predictive ability and is superior to existing measures of non-GAAP reporting quality in distinguishing firms based on actual exclusion persistence. We then highlight several unique applications of our measure, including: (1) identifying characteristics that distinguish firms with high and low exclusion persistence from firms with median persistence, (2) providing evidence that investors’ mispricing of non-GAAP exclusions varies with exclusion persistence, and (3) identifying settings where GAAP earnings is better than non-GAAP earnings at predicting future performance.
Keywords: non-GAAP earnings; non-GAAP reporting quality, voluntary disclosure; exclusion persistence; investor mispricing
JEL Classification: M40; M41; M48
Suggested Citation: Suggested Citation