What’s in a Name? Investors’ Reactions to Non-GAAP Labels

• In Event: Comparability of Financial Statements

Abstract

Many firms report non-GAAP measures, and there is considerable variation in how firms label these measures. I conduct a survey and two experiments to investigate how non-professional investors react to non-GAAP labels and the moderating effects of awareness of managerial discretion in non-GAAP reporting. I find that when awareness of discretion is low, investors are more willing to invest in a firm that reports higher non-GAAP earnings with a more diagnostic label, specifically a label that implies persistent performance (“core”), compared to when the firm uses a less diagnostic label (“adjusted”). Results further suggest that when awareness of discretion is low, investors rely primarily on the diagnosticity of the non-GAAP label in their investment judgments, causing them to overlook the calculation of non-GAAP earnings. When awareness of discretion in non-GAAP reporting is high, investors include assessments of the non-GAAP measure and management credibility in their investment decisions, and react positively to more transparent non-GAAP disclosures.

Author

• Shannon Garavaglia, University Pittsburgh