The Predictive Value of Expenses Excluded from 'Pro Forma' Earnings

Posted: 8 Jan 2004

See all articles by Jeffrey T. Doyle

Jeffrey T. Doyle

Utah State University

Russell J. Lundholm

University of British Columbia - Sauder School of Business

Mark T. Soliman

University of Southern California - Marshall School of Business

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Abstract

We investigate the informational properties of "pro forma" earnings. This increasingly popular measure of earnings excludes certain expenses that the company deems non-recurring, non-cash, or otherwise unimportant for understanding the future value of the firm. We find, however, that these expenses are far from unimportant. Higher levels of exclusions lead to predictably lower future cash flows. We also find that investors do not fully appreciate the lower cash flow implications at the time of the earnings announcement. A trading strategy based on the excluded expenses yields a large positive abnormal return in the years following the announcement, and persists after controlling for various risk factors and other anomalies.

Keywords: Pro forma earnings, capital markets, efficiency, mis-pricing

JEL Classification: M41, M45, G14

Suggested Citation

Doyle, Jeffrey T. and Lundholm, Russell J. and Soliman, Mark T., The Predictive Value of Expenses Excluded from 'Pro Forma' Earnings. Review of Accounting Studies, Vol. 8, No. 2-3, pp. 145-174, June-September 2003. Available at SSRN: https://ssrn.com/abstract=485543

Jeffrey T. Doyle

Utah State University ( email )

College of Business
Logan, UT 84322-3540
United States

Russell J. Lundholm (Contact Author)

University of British Columbia - Sauder School of Business ( email )

2053 Main Hall
Vancouver, British Columbia V6T 1Z2
Canada

Mark T. Soliman

University of Southern California - Marshall School of Business ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

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