Non-GAAP Reporting following Debt Covenant Violation

• In Event: Debt Covenants

Abstract

We investigate how firms vary their non-GAAP reporting policies following debt covenant violations. We find that while the frequency of non-GAAP reporting declines following covenant violations, the quality of non-GAAP reporting improves significantly along multiple dimensions. Specifically, when firms decide to report non-GAAP earnings after a covenant violation, the customized performance metric is (1) placed less prominently within the press release, (2) less likely to meet or beat analysts’ forecasts when the GAAP number falls short, and (3) marginally less likely to exclude recurring expenses. Moreover, the significant association between non-GAAP exclusions and future GAAP operating earnings disappears following covenant violations, indicating improvement in exclusion quality. Overall, our evidence indicates that non-GAAP reporting at least partly reflects managers’ opportunistic motives, and that firms provide less aggressive and more informative non-GAAP disclosures when creditors intervene following covenant violations, suggesting that creditors play a governance role in mitigating opportunism in managers’ non-GAAP disclosures.

Authors

• Theodore E Christensen, University of Georgia

• Hang Pei, George Washington University

• Spencer Ryan Pierce, Florida State University

• Liang Tan, George Washington University