Who Trades on Pro Forma Earnings Information?

51 Pages Posted: 5 Sep 2004

See all articles by Neil Bhattacharya

Neil Bhattacharya

Southern Methodist University (SMU) - Accounting Department

Ervin L. Black

Steed School of Accounting

Theodore E. Christensen

University of Georgia - J.M. Tull School of Accounting; University of Georgia

Richard Mergenthaler

Penn State University


In recent years, many companies have emphasized adjusted-GAAP earnings numbers in their quarterly press releases. While managers use different names to describe these non-standard earnings metrics, the financial press frequently refers to them as "pro forma" earnings. Managers and other advocates of pro forma reporting argue that these disclosures provide a clearer picture of companies' core earnings. On the other hand, regulators, policymakers, and the financial press often allege that managers' pro forma earnings disclosures are opportunistic attempts to mislead investors. Recent evidence suggests that while many pro forma earnings disclosures are altruistically motivated, some may represent managers' attempts to portray overly-optimistic financial performance. If this is the case, less-wealthy, less-sophisticated, individual investors are arguably the most at risk of being misled. Consequently, this study investigates who trades on pro forma earnings information. Our intraday investigation of transactions around earnings announcements containing pro forma earnings information reveals that less-sophisticated investors' announcement-period abnormal trading is significantly positively associated with the magnitude and direction of the earnings surprise based on pro forma earnings. In contrast, we find no association between sophisticated investors' trading and manager-reported pro forma information. Overall, our analyses and numerous robustness tests suggest that the segment of the market that relies on pro forma earnings information is populated predominantly by less-sophisticated individual investors. This evidence is particularly relevant to standard setters and regulators given that Section 401(b) of the Sarbanes-Oxley Act of 2002 and subsequent SEC regulations are specifically designed to protect ordinary investors from misleading pro forma information.

Keywords: Pro forma earnings; corporate disclosure; The Sarbanes-Oxley Act of 2002; SEC regulations

JEL Classification: G14, M41, M43, G38

Suggested Citation

Bhattacharya, Neil and Black, Ervin L. and Christensen, Theodore E. and Mergenthaler, Richard Dean, Who Trades on Pro Forma Earnings Information?. Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=586902

Neil Bhattacharya

Southern Methodist University (SMU) - Accounting Department ( email )

Ervin L. Black

Steed School of Accounting ( email )

307 W Brooks
Norman, OK 73019
United States
405-325-2401 (Phone)

Theodore E. Christensen (Contact Author)

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States

University of Georgia ( email )

Athens, GA
United States

Richard Dean Mergenthaler

Penn State University ( email )

University Park, PA 16802-3306
United States

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