Determinants and Consequences of Non-Gaap Disclosure: A Review of the Literature

Non-GAAP reporting has become popular in the capital market over the last two decades and has generated considerable concerns among external users of the financial report. Since the 1990s, academics and practitioners have started questioning the usefulness of non-GAAP metrics. Most of the studies on pro-forma indicators advocates that managers are mainly driven by the desire to provide more precise information to stakeholders on core earnings, in particular on permanent earnings. However, other researchers find that opportunism might be the reason behind the voluntary disclosure of non-GAAP indicators, especially before the regulatory intervention. Therefore, two opposing theoretical perspectives have emerged: informativeness and opportunism. The informative perspective suggests that non-GAAP earnings tend to be more permanent than GAAP earnings and are more useful in the prediction of future firm performance. Other research plays importance on the value relevance of non-GAAP earnings compared to GAAP results, as they are strongly associated with stock price. Further studies highlight that companies which voluntarily disclose non-GAAP results present a lower quality of GAAP earnings and the non-GAAP reporting serves the purpose to compensate for the lower informativeness of GAAP results. Finally, more recent research has highlighted the positive link between non-GAAP disclosure and the reduction of information asymmetries. Differently, the opportunistic perspective assumes that non-GAAP disclosure serves the purpose of misleading the users of financial statements, presenting a higher business performance compared to that emerging from the use of GAAP metrics. Empirical evidence shows that managers disclose pro forma earnings to conceal losses, to report positive earnings growth, to meet or beat analysts’ expectations and to increase investor perceptions of earning credibility. Although most of the studies have examined the US setting, the phenomenon of non-GAAP earnings is not confined exclusively to the US. Additional research has recently been conducted also in Australia, New Zealand, Canada, South Africa and Europe. Studies in the European settings have shown that almost 80% of companies in the largest cities reports at least one non-GAAP metric in their earning releases. With reference to the UK setting the percentage of companies that communicate non-GAAP earnings has increased from 40% in 1993 to 75% in 2001, reaching a peak of 90% after the transition to IFRS in the 2005. In spite of the relevance of non-GAAP earnings, there are several differences among countries related to both institutional and economic factors. For example, in the US context the non-GAAP earnings are mainly reported by hi-tech companies, while outside US there is no sector specificity. Furthermore, European companies are more consistent in non-GAAP reporting policies than their US counterparts and are less prone to opportunistically exclude recurring items, such as depreciation. Moving from the dual nature of non-GAAP reporting, this study provides a systematic review of the literature with the aim to identify the main empirical evidence supporting the informative or the opportunistic perspective, pointing out the areas that need further investigation by scholars and practitioners.