The Regulation of Non-GAAP Disclosure: The Effect of New Compliance and Disclosure Interpretations by the SEC in 2010

• In Event: Financial Accounting and Reporting V

Abstract

I examine whether the issuance of new Compliance and Disclosure Interpretations (new CDI) in 2010 influenced the frequency and quality of non-GAAP disclosure. The new CDI were issued because the Division of Corporate Finance in the U.S. Securities and Exchange Commission (SEC) believed its previous interpretive guidance on non-GAAP disclosure issued in 2003 was more restrictive than originally intended. Since the issuance of new CDI represents relaxed enforcement of Regulation G and Regulation S-K, it provides a unique experimental setting to test whether excessive regulation influences the frequency and quality of non-GAAP disclosure. More importantly, it also allows me to test whether changes in interpretive guidance, not actual regulation, affect managerial decisions as to how managers utilize non-GAAP earnings. I find that firms are more likely to disclose non-GAAP earnings after the issuance of new CDI, suggesting excessive regulation may lead to underproduction of information, thereby preventing a richer information environment. The quality of non-GAAP exclusions improves after the issuance of new CDI, consistent with the view that excessive regulation on non-GAAP disclosure precludes further improvement of exclusion quality. I provide evidence that excessive regulations qualitatively diminish the information environment. Relaxed enforcement of excess regulation allows non-opportunistically motivated managers to disclose non-GAAP earnings that more effectively communicate permanent earnings. Finally, I provide unique evidence that the SEC’s interpretive guidance, not actual regulation, affects firms’ reporting decisions.

Author

• Hangsoo Kyung, The City University of New York