Analysts and investors beware - the country is not irrelevant when you’re analyzing non-GAAP results.
Researcher: Ana Marques
Professors Ana Marques (Nova SBE) and Helena Isidro (ISCTE) analyze managers’ disclosure of alternative earnings measures (which do not follow any accounting standard), using hand-collected data for a sample of large European firms. Results suggest that in environments in which there is more pressure to achieve earnings benchmarks and less opportunity to manipulate GAAP earnings, managers use more non-GAAP earnings disclosures to meet the benchmarks.
When earnings don’t meet the benchmarks
Managers are motivated to disclose, in their announcements, earnings which meet or beat strategic earnings benchmarks such as: (i) analysts’ consensus, (ii) profits from previous year (to show profit growth), and (iii) positive figures (in order to avoid reporting a loss).
When the earnings figures, according to generally accepted accounting principles (GAAP), do not meet the benchmarks, managers may disclose alternative earnings measures which achieve that purpose. These non-GAAP earnings measures are constructed by managers and voluntarily disclosed.
In this paper the authors investigate the influence of countries’ institutional and economic factors on managers’ non-GAAP disclosures.
International differences matter
Using non-GAAP data collected from the annual earnings announcements of a sample of the largest European firms, during the period 2003-2007 the researchers find that:
• in countries where there is pressure to achieve earnings benchmarks and less opportunity to manipulate GAAP earnings managers are more likely to use non-GAAP measures to meet or beat earnings benchmarks that GAAP earnings would miss. The factors analyzed are efficient law and enforcement, strong investor protection, developed financial markets, and good communication and dissemination of information;
• when calculating non-GAAP measures managers in countries with developed institutional and economic conditions are more likely to make adjustments for recurring expenses such as R&D, depreciation, and stock-based compensation expenses. This decreases the usefulness of such measures to portray core earnings and is usually a sign of opportunistic disclosures of such measures.
Implications for practice and regulation
These findings reveal the effects of cross-country variation in economic and institutional factors in non-GAAP reporting strategies, which are relevant to market participants interested in corporate disclosures, such as financial analysts and professionals from investors’ relations departments. They are also relevant to policy-makers addressing the introduction of policies to discipline non-GAAP disclosure in Europe: the European Securities and Markets Authority (ESMA) released its first consultation paper on this topic on February of 2014.
About the authors:
• Ana Marques is an Associate professor of accounting at Nova School of Business and Economics. She holds a PhD from the University of Texas at Austin.
• Helena Isidro is an Associate Professor of accounting at Instituto Universitário de Lisboa (ISCTE-IUL). She holds a PhD from Lancaster University.
The role of institutional and economic forces in the strategic use of non-GAAP disclosures to beat earnings benchmarks (with Helena Isidro) – European Accounting Review, forthcoming. Available here.