Pro Forma Disclosure and Investor Sophistication: External Validation of Experimental Evidence Using Archival Data

Posted: 29 Sep 2006

See all articles by Kristian D. Allee

Kristian D. Allee

University of Arkansas - Department of Accounting

Neil Bhattacharya

Singapore Management University - School of Accountancy; 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

Multiple version iconThere are 2 versions of this paper

Abstract

Insights on how ordinary, less-sophisticated investors interpret and process management-issued pro forma earnings numbers are useful to regulators because of concerns that pro forma disclosures are misleading to ordinary investors. Two recent experimental studies (Frederickson and Miller, 2004 and Elliott, 2006) find that the existence of a pro forma number in the earnings press release as well as the relative placement of the pro forma and GAAP earnings figures within the press release affect the judgments of less-sophisticated investors but not those of more-sophisticated investors. Experimental and archival methodologies complement one another and results that persist in both settings are likely to be robust to both internal and external validity concerns. Therefore, we complement experimental evidence using trade-size-based proxies constructed from intraday transactions data to distinguish the trading activities of less-sophisticated investors from more-sophisticated investors. Our results suggest that less-sophisticated investors rely significantly more on quarterly earnings press releases that include a pro forma number than on those that do not, while more-sophisticated investors exhibit the opposite behavior. This result is consistent with Frederickson and Miller's experimental evidence. Further, consistent with Elliott's results, we find that less-sophisticated investors rely more on the pro forma figure when it is placed before the GAAP earnings number in the press release, while more-sophisticated investors' trading behavior is unaffected by the relative placement of the two earnings metrics. We conclude that the existence of a pro forma number as well as its strategic placement in the press release generally affect the judgments of less-sophisticated (but not more-sophisticated) investors and these inferences are robust because they persist in both experimental and archival settings.

Keywords: Pro forma earnings, investor sophistication, Sarbanes-Oxley Act of 2002, complementary research methodologies

JEL Classification: G14, M41, M3, M45, C91, G38

Suggested Citation

Allee, Kristian D. and Bhattacharya, Neil and Black, Ervin L. and Christensen, Theodore E., Pro Forma Disclosure and Investor Sophistication: External Validation of Experimental Evidence Using Archival Data. Accounting, Organizations and Society, Forthcoming. Available at SSRN: https://ssrn.com/abstract=933354

Kristian D. Allee

University of Arkansas - Department of Accounting ( email )

University of Arkansas
Business Building 458
Fayetteville, AR 72701
United States
479-575-5227 (Phone)

Neil Bhattacharya

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

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

United States
214-768-3082 (Phone)
214-768-4099 (Fax)

HOME PAGE: http://www.cox.smu.edu

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

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