A Firm-Quarter Measure of Non-GAAP Exclusion Persistence

55 Pages Posted: 13 Apr 2021

See all articles by Kurt H. Gee

Kurt H. Gee

Penn State - Smeal College of Business

Ken Li

McMaster University - Michael G. DeGroote School of Business

Benjamin C. Whipple

University of Georgia - C. Herman and Mary Virginia Terry College of Business

Date Written: April 13, 2021

Abstract

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

Gee, Kurt H. and Li, Ken and Whipple, Benjamin C., A Firm-Quarter Measure of Non-GAAP Exclusion Persistence (April 13, 2021). Available at SSRN: https://ssrn.com/abstract=3825314 or http://dx.doi.org/10.2139/ssrn.3825314

Kurt H. Gee (Contact Author)

Penn State - Smeal College of Business ( email )

354 Business Building
University Park, PA 16802
United States

Ken Li

McMaster University - Michael G. DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada

Benjamin C. Whipple

University of Georgia - C. Herman and Mary Virginia Terry College of Business ( email )

Brooks Hall
Athens, GA 30602-6254
United States

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