Audits of Non-GAAP Earnings: Evidence from Adjusted EBITDA in Segment Disclosures

Abstract

We provide evidence on an important question to capital markets: “Would subjecting non-GAAP metrics to audit affect the quality of the metrics?” Focusing on instances where adjusted EBITDA is disclosed in firms' segment notes, which subjects the EBITDA metric to audit requirements, we find that the adjustments made when calculating EBITDA are of higher quality when subject to audit. Further tests help rule out concerns that the results are driven by a firm commitment to having high-quality adjusted EBITDA or firms with more informative EBITDA being more likely to use adjusted EBITDA in segment notes. We also find that analysts follow manager-provided adjusted EBITDA more when the measures are audited and that managers disclose audited EBITDA metrics more prominently in their earnings announcements. Overall, our evidence indicates that, at least in the context of our study, the answer to our research question is yes—auditing non-GAAP metrics affects their quality.

Keywords: adjusted EBITDA, non-GAAP, audit

JEL Classification: M41, M42