What’s in a Name? Investors’ Reactions to Non-GAAP Labels

Abstract

Using a mixed-methods approach, I investigate how the terms that firms use to label non-GAAP earnings interact with investors’ scrutiny of non-GAAP reporting to affect investors’ information search behavior and investment decisions. I first provide descriptive evidence on the non-GAAP labels used in practice, followed by a survey to understand what investors believe these labels convey about earnings quality. Finally, in an experiment, I find that investors who are more likely to scrutinize non-GAAP reporting are not affected by non-GAAP labels when deciding to seek out the non-GAAP reconciliation, and react positively to appropriately-used labels. However, investors who are less likely to scrutinize non-GAAP reporting rely on the cue provided by the label when deciding whether to seek out the non-GAAP reconciliation and are more likely to be misled by inappropriately-used labels. This study is informative to regulators, who have expressed concern over the mislabeling of non-GAAP measures, and to managers, who are often criticized for their misuse of discretion in non-GAAP reporting.

Keywords: Non-GAAP, information search, investor judgments, management credibility, experiment, non-professional investors