Impression Management and Non‐GAAP Disclosure in Earnings Announcements

• Author: Helena Isidro,Encarna Guillamon‐Saorin,Ana Marques
• DOI: http://doi.org/10.1111/jbfa.12238
• Published date: 01 March 2017
• Date: 01 March 2017

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 44(3) & (4), 448–479, March/April 2017, 0306-686X

doi: 10.1111/jbfa.12238

Impression Management and Non-GAAP

Disclosure in Earnings Announcements

Encarna Guillamon-Saorin, Helena Isidro and Ana Marques∗

Abstract: We study the market’s reaction to the disclosure of non-GAAP earnings measures

that are combined with high impression management. We constructan impression management

score that captures several communication techniques that managers often use to positively bias

investors’ perceptions of firm performance. We hand-collect and code both quantitative and

qualitative information from earnings announcement press releases of large European firms.

Our results indicate that non-GAAP measures are informative to capital markets. However,

non-GAAP adjustments are more persistent when accompanied by higher levels of impression

management. This evidence is consistent with managers attempting to distort users’ perceptions

when non-GAAP adjustments are of lower quality. Market reaction tests suggest that investors

are able to see through managers’ intentions and discount non-GAAP information that is

accompanied by high impression management. Moreover, investors in more sophisticated

markets penalize non-GAAP measures communicated with high impression management. Our

results are robust to a battery of sensitivity tests, including the use of a machine-coded tone

measure.

Keywords: pro forma earnings, alternative performance measures, street earnings, disclosure

tone, emphasis, sophisticated investors, shareholder protection

∗The first author is from the Universidad Carlos III de Madrid, Spain. The second author is from the

Instituto Universit´

ario de Lisboa (ISCTE-IUL), Lisbon, Portugal. The third author is from the Nova School

of Business and Economics & Indian Institute of Management Bangalore, India. The authors appreciate

the valuable comments received from Ted Christensen, Stephen Taylor, Yinglei Zhang, Francesco Bova,

Beatriz Garcia, Ross Jennings, as well as those received from the participants at the 2016 Journal of

Business Finance & Accounting Conference, the 2015 UTS Summer Accounting Conference, the 2014 Mid-

year meeting of the International Accounting Section of AAA, the 2013 Chulalongkorn Accounting and

Finance Symposium, the 2013 Conference of the University of Miami, the EAA 2012 annual meeting, the IX

Workshopon empirical research in financial accounting, Nova School of Business and Economics, Grenoble

Ecole de Management, Bristol University,Durham University, Universidad de Navarra, Cass Business School,

Bangor University, Indian Institute of Management Bangalore, and University of Auckland. They also thank

Ant´

onio Miguel for providing the data on international risk factors. This study was supported by the Founda-

tion for Science and Technology in Portugal (grant PTDC/EGE-GES/103770/2008). Encarna Guillamon-

Saorin acknowledges financial contribution from the Spanish Ministry of Science and Innovation (SEJ2007-

67582-C02-02/ECON, ECO2010-19314), Ministerio de Economia y Competitividad (2014/00452/001) and

Comunidad Autonoma de Madrid (SEJ2008-00059-003). Ana Marques also acknowledges financial support

received from Nova Forum. Finally, the authors are grateful for the excellent research assistance of Arash

Aloosh and Lu´

ıs Ara´

ujo. (Paper received November 2015, revised revision accepted January 2017).

Address for correspondence: Ana Marques, Nova School of Business and Economics & Indian Institute

of Management Bangalore, IIMB, Bannerghatta Road, Bengaluru 560076, India.

e-mail: ana_marques@novasbe.pt

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IMPRESSION MANAGEMENT AND NON-GAAP DISCLOSURE 449

1. INTRODUCTION

Generally accepted accounting principles (GAAP) are the standard framework of

guidelines for financial accounting. Non-GAAP measures can be disclosed to inform

capital markets about recurring performance or to portray a firm’s performance

in an optimistic manner, a practice that may mislead investors. We study the

disclosure of non-GAAP earnings measures that are accompanied by impression

management communication techniques, and explore how this varies across insti-

tutional environments. Impression management is a process in which managers

select and present information, either qualitative or quantitative, in a way that

distorts users’ perceptions of corporate achievements (Neu et al., 1998). Our results

indicate that non-GAAP measures are informative to capital markets. However, we

find evidence consistent with managers using high levels of impression management

to mask the recurring nature of some non-GAAP adjustments. We also find that

investors perceive this combination to be opportunistic and penalize firms for this

behavior. Thus, while there is a positive market reaction to non-GAAP adjustments,

on average, investors ignore the adjustments that are accompanied by high im-

pression management. The country-level results suggest that this reaction is more

pronounced in environments with a stronger presence of sophisticated financial

statement users (institutional investors and financial analysts), and stronger investor

protection.

Since markets value persistent earnings (Collins and Kothari, 1989), firms have

incentives to separate permanent and transitory earnings components. However,

earnings measurement and disclosure is constrained by GAAP and subject to mon-

itoring. In their search for more flexible ways to convey information about earn-

ings persistence, managers have trended toward the voluntary disclosure of non-

GAAP performance measures in earnings press releases. Prior research suggests

that investors perceive non-GAAP earnings to be informative (Bradshaw and Sloan,

2002; Bhattacharya et al., 2003), but expresses concerns about the possibility of

strategic disclosure to positively bias investors’ perceptions (Andersson and Hellman,

2007; Bhattacharya et al., 2007; Cormier et al., 2011). Therefore, the challenge for

investors and regulators is to allow management freedom to use non-GAAP earnings

adjustments to communicate key earnings components while simultaneously limiting

opportunistic disclosures (Young, 2014).

In contrast to the US where regulation specifically constrains non-GAAP disclosure,

in Europe non-GAAP reporting is virtually unregulated. In addition, capital markets

and institutional mechanisms are less developed in Europe than in the US, suggesting

that the potential for these disclosures to mislead investors is likely higher. The

European Financial Reporting Advisory Group (EFRAG), an organization which

provides the European Commission with technical advice on accounting matters,

has stressed that non-GAAP disclosures of large European firms are inconsistent and

obscure (EFRAG, 2009). Consistent with these concerns, the European Securities and

Markets Authority (ESMA) recently published a set of guidelines for the disclosure of

non-GAAP measures (ESMA, 2015).

While non-GAAP earnings may be used to manage investors’ perceptions, they

are not the only communication tool available to managers. Earnings press releases

offer great flexibility regarding both the format and the presentation style of the

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450 GUILLAMON-SAORIN, ISIDRO AND MARQUES

information.1Previous studies, examining the placement of non-GAAP earnings in

press releases, find that firms commonly place non-GAAP earnings more prominently

than GAAP measures, and that higher relative emphasis of non-GAAP information

affects the judgments of some investors (Bowen et al., 2005; Elliott, 2006; Allee et al.,

2007; Isidro and Marques, 2015). We extend these results by examining multiple

communication strategies, which we refer to as impression management techniques.

Thus, we provide a comprehensive analysis, considering the possibility that investors’

reactions may be affected by: (1) the use of positive tone; (2) the emphasis given

to non-GAAP measures; and (3) the use of performance comparisons (selecting

benchmarks that give the impression of performance achievement). We consider

emphasis in terms of (i) the location of the measure in the press release, (ii) the

repetition of non-GAAP information, and (iii) the reinforcement of keywords. We use

content analysis to construct a firm-year score of impression management related to

non-GAAP disclosures.

Whether or not investors perceive the combination of impression management

with non-GAAP disclosures to be misleading is an important empirical question.

If European investors are capable of recognizing and understanding this type of

disclosure combination, then strict regulation, which is costly to design and enforce,

may not be necessary. We hand-collect data and hand-code non-GAAP and impression

management practices from the first two sections of firms’ earnings announcement

press releases. This focus is consistent with Entwistle et al. (2006), who state that the

headline is ‘the portion of the press release with highest profile, the language which is

first read and which tends to be picked up by the financial press and newswire’.

In the spirit of Frankel et al. (2011) and Jennings and Marques (2011), we

analyze the cross-sectional variation in the persistence of non-GAAP adjustments to

make inferences about informative versus opportunistic intentions. Consistent with

these studies, we find that the non-GAAP adjustments made by large European firms

are generally recurring in nature. We extend this literature by documenting that non-

GAAP adjustments that are accompanied by high impression management are more

persistent (i.e., of lower quality).

Our first hypothesis explores whether investors’ short-window reaction to non-

GAAP disclosures around the earnings announcement date varies with the level of

impression management.2In line with prior studies, which generally use US data, we

find an overall positive market response to non-GAAP disclosures. However, investors

ignore non-GAAP disclosures that are accompanied by high impression management.

This result suggests that investors interpret the combination of the two disclosure

1 Press releases are widely used by the business community and offer ample opportunity for discretionary

disclosures. Prior research finds evidence of strategic use of communication techniques, such as positive

language tone, to influence investors’ perceptions about firm performance (Lang and Lundholm, 2000;

Huang et al., 2014). Prior studies also find the use of impression management to be associated with other

strategic behaviour, such as earnings management (Godfrey et al., 2003; Aerts and Cheng, 2011).

2 One could argue that, given the difficulty of identifying who writes the press release (Merkl-Davies and

Brennan, 2007; Garcia Osma and Guillamon-Saorin, 2011), it is unlikely that the person preparing the

press release is the same person who determines the non-GAAP exclusions and its presentation in the press

release. The counterargument is that the manager is the person accountable for the content of the press

release. Given the lack of evidence in the literature, we can assume that the quality of firm communication

is an equilibrium outcome (Ball, 2006), which implies consistent quality levels across the range of reported

information prepared within a firm, regardless of the number of parties involved (Gronstedt, 1996).

This logic leads to the general expectation that impression management and non-GAAP information are

positively associated.

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