The Informativeness of Non-GAAP Earnings: An Examination of Adverse Selection around Earnings Announcements

• In Event: Non-GAAP Earnings: Opportunistic or Informative?

Abstract

In a dealer market, market makers increase the adverse-selection component of the bid-ask spread when they detect information-based trades. Based on an analysis of adverse selection, before and after earnings announcements, we find evidence which suggests that non-GAAP street earnings improve the price discovery process. We show that (a) adverse selection prior to earnings announcements is unusually high in quarters when a non-GAAP street earnings number is expected at the earnings announcement, (b) the reduction in adverse selection (post-announcement less pre-announcement) is significantly larger when I/B/E/S reports a non-GAAP street earnings number, and (c) the reduction in adverse selection is increasing with the magnitude of the pro forma exclusion (i.e., the absolute value of the difference between GAAP and non-GAAP earnings). Our results suggest that non-GAAP street earnings increase the amount and precision of earnings information and help narrow information asymmetry between informed and uninformed traders following earnings announcements.

Authors

• Qianyun Ivy Huang, Queens College–CUNY

• Terrance R Skantz, The University of Texas at Arlington