Standardization as the answer? The Properties of Non-GAAP Earnings in China

Abstract

In November 2024, the FASB issued an Invitation-to-Comment (2024-ITC100) on a proposal to standardize non-GAAP financial metrics commonly reported in earnings releases. While predicting the impact of standardization in the United States is difficult, this paper explores the quality of non-GAAP earnings in a regulatory regime that has already standardized non-GAAP earnings. In contrast to the discretionary nature of non-GAAP earnings in the United States, the China Securities Regulatory Committee (CSRC) issues strict guidelines on the type of items excluded from non-GAAP earnings. In contrast to findings in studies on U.S. firms, our results generally indicate that Chinese non-GAAP exclusions are of higher quality and understood by investors. However, we find that Chinese non-GAAP exclusions are lower quality when equity market pressures increase. Our results show that non-state-owned firms, high institutional ownership firms, and high analyst coverage firms in China (firms that mimic U.S. firm characteristics) tend to report lower-quality non-GAAP exclusions. Thus, standardization in the U.S. may have a limited impact on curbing manipulation through non-GAAP earnings and negatively impact the manager’s ability to communicate private information to investors. Our results provide insights into the potential outcomes of standardizing non-GAAP earnings and highlight the distinct properties of non-GAAP earnings that are useful when valuing Chinese firms.  

Keywords: standardization, non-GAAP reporting, disclosure regulation, China

JEL Classification: G18, G38, K22, M40, M41, M47