Adjusted versus unadjusted earnings: An empirical analysis of pro forma adjustments in large German public companies

• Published date: 01 July 2023
• Author: Marcel Wiek,Korbinian Eichner
• Date: 01 July 2023
• DOI: http://doi.org/10.1002/jcaf.22611

Received:  October Accepted:  December 

DOI: ./jcaf.

RESEARCH ARTICLE

Adjusted versus unadjusted earnings: An empirical analysis

of pro forma adjustments in large German public companies

Marcel Wiek1Korbinian Eichner2

Department of Controlling, Finance and

Accounting, Pforzheim University,

Pforzheim, Germany

Business School, Pforzheim

University/University of St.Gallen (HSG),

Pforzheim, Germany

Correspondence

Korbinian Eichner,Professor of Corporate

Finance at Pforzheim University, Lecturer

in Finance at University of St. Gallen

(HSG). Postal address: Prof. Dr.Korbinian

Eichner, Pforzheim University,

Tiefenbronner Str. , Pforzheim,

Germany.

Email:

korbinian.eichner@hs-pforzheim.de

Abstract

This article analyzes non-GAAP, pro forma earnings metrics of large German

publicly traded companies to better understand their usage and relevance in

practice. Webase our analysis on a hand collected data set compiled from annual

reports. Almost all companies in our data set use pro forma earnings. Typically,

legal, restructuring, acquisition and accounting related costs get adjusted. EBIT,

EBITDA, EPS and Net income arethe most frequently adjusted earnings metrics.

In almost all observed cases, pro forma earnings are higher than their underlying

GAAP earnings. Our study addresses the challenge of investors to understand a

company’s “true” operating performance. Only when one understands the his-

torically observable financial performance, one can make better predictionsof its

recurring, future financial performance. The article adds to the existing literature

by analyzing in which part of the annual report pro forma earnings are typically

disclosed, how transparent they are presented and reconciled, and what impact

adjustments have compared to the unadjusted GAAP earnings.

KEYWORDS

asymmetric information, corporate finance, corporate valuation, financial reporting, market

approach

1 INTRODUCTION

When analyzing financial publications of public com-

panies, one frequently encounters financial performance

measures like “EBIT before special items,” “Underlying

EBITDA,” or “Core EPS.” These so-called pro forma earn-

ings, also referred to as “non-GAAP” metrics, are derived

from company specific adjustments on accounting com-

pliant earnings metrics. These adjustments are intended

to eliminate one-time and/or extraordinary income and

expense items which the reporting entity does not consider

to be a reflection of its financial performance.

This is an open access article under the terms of the Creative Commons Attribution-NonCommercial-NoDerivs License, which permits use and distribution in any medium,

provided the original work is properly cited, the use is non-commercial and no modifications or adaptations are made.

©  The Authors. Journal of CorporateAccounting & Finance published by Wiley Periodicals LLC.

Pro forma earnings metrics can be used by financial

analysts to better estimate the “true” operating perfor-

mance of a company. One can argue that certain line

items within the annual reports, in particular non-cash

and non-recurring items, are not as relevant when it comes

to determining the performance of a given company.

Furthermore, it can be proposed that pro forma met-

rics reflect the managerial intentions to for one reduce

reporting complexity along with providing additional use-

ful information for estimating future cash-flow.One can

take the continuous use and increase in pro forma met-

rics over the past  years as a general approval in the

J Corp Account Finance. ;:–. wileyonlinelibrary.com/journal/jcaf 47

48 WIEK  EICHNER

usefulness of non-GAAP metrics to assess the performance

of a company.

However, in a more critical manner pro forma earnings

are also referred to as “street earnings,”“Everything but

Bad Stuff,”and “Earnings before Bad Stuff.”This is since

the decision and freedom of adjusting earnings is largely a

managerial decision. They can potentially choose to mis-

lead investors by excluding certain line items and negative

effects of reported earnings metrics. This has the possibil-

ity to increase future company expectancies. Additionally,

the fact that pro forma earnings are shown dynamically

next to, under or above GAAP earnings, has the poten-

tial to reduce the comparability as well as the transparency

of the given accounting information.Furthermore, can

and do managers exclude recurring expenses which are

part of the core business like, for example, stock based

remuneration.

With the available degree of freedom when it comes to

pro forma metrics in annual reports, regulators havevoiced

concerns. In the US as early as in , with the Sarbanes-

Oxley act, the SEC mandated action. Companies within

the US capital market, therefore, must reconcile their pro

forma earnings to the GAAP earnings.Similarly to the

SEC, the CESR issued recommendations for the usage of

pro forma metrics as early as in . Since then, and in

particular with the adoption of the IFRS in  for par-

ent companies within Europe that trade on a regulatory

market, the IASB continuously issued recommendations

and standards for the use of pro forma metrics.

The main objective of this research paper is to find

out how widespread the usage of pro forma earnings

in large German public companies is. Furthermore, the

data of this research shows where pro forma earnings are

found in annual reports of publicly traded companies in

Germany, how and in which detail these pro forma mea-

sures are explained, what verbiage is used to indicate pro

forma earnings and whether pro forma earnings tend to

be an increase or decrease in value compared to their

GAAP earnings counterpart. To achieve this goal current

annual group reports from companies in the German DAX

stock index as well as the German MDAX index from the

year  are analyzed. The insights are then presented

and furthermore compared to studies already concluded.

The purpose of the comparison is to show the change

due to differences in geographical location, the change of

annual group report practices owing to time as well as

contrasting the usage of pro forma metrics in compari-

son to other reporting measures, such as earnings before

metrics.

Chapter one provides an introduction into the topic

of pro forma earnings metrics. Chapter two focusses on

the theoretical background of what pro forma earnings

metrics are and includes a delimitation to the similar met-

ric “earnings before.” Besides, key reasons for companies

reporting pro forma earnings metrics are outlined. Chap-

ter three presents an overview of existing research on

the topic. Chapter four outlines our empirical data and

its analysis. First, the core research questions are high-

lighted. Besides, the data collection process is presented.

In addition, the data sample size and its components are

discussed. Consecutively the results for pro forma metrics

in large German public companies in  is presented.

This includes the number of pro forma metrics used as

well as the percentage of companies using pro forma earn-

ings. Furthermore, qualitative details on the location of

pro forma earnings metrics in the annual reports, as well

as how company name and reconcile them are presented.

Additionally, the nature of the earnings adjustments is

presented and analyzed. Lastly, we provide information

on the relative increase and decrease of GAAP earnings

to non-GAAP earnings, as well as further details as to

whether these adjustments are usually positive or negative

in nature. We conclude by providing information on the

limitations of our results. A summary of our results and

an outlook for further research on the topic is part of the

conclusion in chapter five.

2FUNDAMENTALS OF PRO FORMA

EARNINGS

2.1 Definition

The term “pro forma” originates from Latin and translates

to “for form.” With the absence of a uniform and offi-

cial definition, pro forma earnings are usually described

as metrics which adjust or modify the bottom-line earn-

ings of an income statement. Companies take a GAAP

compliant earnings metric as the basis and exclude certain

line items. As such pro forma earnings metrics are most of

the time indicated with the word “adjusted” within earn-

ings publications of companies. Literature furthermore

uses a variety of synonyms to describe pro forma metrics,

in particular alternative profitability measures and the

previously mentioned “non-GAAP” as well as “adjusted

GAAP” terminologies. The terms pro forma, pro forma

earnings, pro forma metrics as well as pro forma earnings

metrics for the purpose of this paper are synonyms to the

previously described terms and therefore can be and are

used interchangeably.

In comparison to pro forma metrics, “earnings before”

metrics describe interim results of the profit and loss state-

ment within annual reports of companies. These results

come in a variety of ways.Typically, they exclude line items

in a GAAP conformant manner. EBIT (Earnings before

interest and taxes) and EBITDA (Earnings before interest,