Non‐GAAP earnings disclosure post 2010 SEC regulation change

• Author: Theresa F. Henry,Rob R. Weitz,David A. Rosenthal
• Published date: 01 July 2020
• DOI: http://doi.org/10.1002/jcaf.22435
• Date: 01 July 2020

BLIND PEER REVIEW

Non-GAAP earnings disclosure post 2010 SEC regulation

change

Theresa F. Henry

1

| Rob R. Weitz

2

| David A. Rosenthal

2

1

Department of Accounting and Taxation,

Stillman School of Business, Seton Hall

University, South Orange, New Jersey

2

Department of Computing and Decision

Sciences, Stillman School of Business,

Seton Hall University, South Orange, New

Jersey

Correspondence

Theresa F. Henry, Department of

Accounting, Stillman School of Business,

Seton Hall University, South Orange, New

Jersey.

Email: theresa.henry@shu.edu

Abstract

In this article, we explore the disclosure of non-GAAP earnings by large, publicly

traded companies, and the possible impact of the 2010 change in Regulation G

and S-K on corporate reporting behavior. The reporting of non-GAAP earnings

measures is not required for public companies, nor are these measures audited.

There exists considerable leeway in the manner and extent to which companies

can report and calculate non-Generally Accepted Accounting Principles (GAAP)

earnings. Not surprisingly, non-GAAP reporting standards are a concern for regu-

lators trying to uphold the consistency and comparability of financial reporting.

We collected the fourth quarter earnings releases of Standard and Poor's (S&P)

100 companies for the years 2010 through 2016 to study their reported annual

non-GAAP earnings disclosures, if any. Adjustments made to GAAP earnings

were classified into eight common categories (e.g., Restructuring Charges, Tax

Related Benefits/Charges) in order to calculate the magnitude, materiality, and

nature of the adjustments reported. Our analysis shows that the number of com-

panies reporting non-GAAP earnings increased over our period of study, with a

significant increase occurring after the 2010 liberalization of the Regulation G

rules.Wefoundanincreaseinallcategories of adjustme nts and that most were

−10% to +10% of net income. The median values of adjustments were positive in

almost all the categories indicating non-GAAP adjustments generally increase

non-GAAP net earnings. We observed many instances of companies reporting the

same category of non-GAAP earnings over multiple years. Further, we find that

companies that do not report non-GAAP earnings have higher market capitaliza-

tions than non-GAAP earnings reporters. This study contributes to the res earch of

non-GAAP earnings reporting with an extensive analysis of the disclosure, the

nature and magnitude of adjustments companies report, and the characteristics of

those companies that choose to disclose.

KEYWORDS

non-GAAP earnings, SEC regulation

1|INTRODUCTION

A non-generally accepted accounting principles (GAAP)

financial measure is an adjustment to the most directly

comparable GAAP measure reported on the audited

financial statements. Non-GAAP measures are not

required to be reported nor are they audited. The calcula-

tion of these measures is highly subjective and varied and

Received: 23 August 2019 Revised: 14 November 2019 Accepted: 23 November 2019

DOI: 10.1002/jcaf.22435

114 © 2019 Wiley Periodicals, Inc. J Corp Acct Fin. 2020;31:114–134.wileyonlinelibrary.com/journal/jcaf

so is not necessarily comparable across industries or com-

panies. Common non-GAAP financial measures are earn-

ings before interest, taxes, depreciation and amortization

(EBITDA), adjusted EBITDA, and non-GAAP Earnings.

These measures often parcel out different aspects of a

company's operations and/or remove the effects of large,

unusual, and/or nonrecurring transactions

(PriceWaterhouseCoopers, 2014). This study focuses on

the reporting of non-GAAP earnings, which has come

under increased scrutiny in recent years. Changes in reg-

ulation surrounding this disclosure have impacted the

manner and extent to which companies disclose. There

is, in any case, ongoing debate over the degree to which

non-GAAP earnings and other measures should be regu-

lated. Public companies are given latitude to adjust

GAAP earnings in order to calculate the non-GAAP earn-

ings they feel is a better representation of their perfor-

mance. This latitude, however, hampers the consistency

and comparability that are fundamental to financial

reporting.

Non-GAAP financial measures are often reported in

the Management's Discussion and Analysis section of a

company's quarterly (10-Q) or annual (10-K) financial

report filings. They also can be reported in earnings

releases and other forms of communication a company

uses to provide additional insights into its business,

beyond those found in the financial statements prepared

according to US GAAP. While non-GAAP measures are

not subject to audit, they are regulated by the SEC. Public

companies must comply with Regulation G which

addresses all non-GAAP financial disclosures as well as

Item 10(e) of Regulation S-K, which specifically addresses

non-GAAP information included in SEC filings. That is,

non-GAAP disclosures in 10-Q and 10-K filings are sub-

ject to stricter regulations than those appearing in other

communications, such as earnings press releases.

In this article, we explore the question of the impact

the 2010 change in Regulation G and S-K had on corpo-

rate reporting behavior of non-GAAP earnings by large,

publicly traded companies. Specifically, was there an

increase in the number of companies reporting non-GAAP

earnings after 2010 and if so, what was the extent and

nature of the increase? Nichols, Gray, and Street (2005)

and Webber, Nichols, Street, and Cereola (2013) studied a

similar question in prior periods. Our work extends this

research thread by analyzing corporate reporting behavior

in the current period and by refining some of the measures

used in the prior research. Further, we explore the extent,

type, and frequency of recurrence of non-GAAP earnings

and compare the companies that report non-GAAP earn-

ings with those that only report GAAP earnings.

Our sample is comprised of those companies listed in

the Standard and Poor's (S&P) 100 for the year 2014. We

collected the fourth quarter earnings releases of these

companies for the years 2010 through 2016 to study their

reported non-GAAP earnings disclosures, if any.

Throughout this article, the terms income and earnings

are used interchangeably as both terms are used in finan-

cial reporting, business practice, and academic research.

We collected data for all adjustments made to GAAP

earnings in order to calculate non-GAAP earnings and

categorized them by nature of adjustment. Eight types of

adjustments stood out as significant and are reported sep-

arately in our results. Those that occurred less frequently

were classified as Other Adjustments. The collection of

all adjustment data allowed us to compare those compa-

nies that only report GAAP earnings (“GAAP-only”com-

panies) with those that also report non-GAAP earnings.

We found that the number of companies reporting

non-GAAP earnings increased during our period of

study, particularly after 2010. We investigated a possible

relationship between GAAP-only reporting and firm size,

as measured by total assets, sales, and market capitaliza-

tion. We found a significant relationship between

GAAP-only reporting and market cap, but no significant

relationship between GAAP-only reporting and sales or

total assets. We review the frequency and materiality of

the categories of adjustments as a percentage of net

income, in accordance with common business practice

and document numerous material adjustments during

our period of study. Our work contributes to the field of

research focused on non-GAAP financial reporting with

new outcomes related to the change in reporting behav-

ior after the relaxation of Regulation G in 2010, the char-

acteristics of companies that choose to report non-GAAP

earnings and the types, materiality, and frequency of the

adjustments selected by management.

The remainder of this article is organized as follows:

Section 2 summarizes the SEC regulation over non-

GAAP measures since 2003. Section 3 reviews the related

literature and Section 4 introduces the hypotheses.

Section 5 describes the data collection and categorization

process. Section 6 presents the results of our analyses and

test of hypotheses. Finally, Section 7 concludes.

2|REGULATION OVER NON-

GAAP MEASURES

The SEC issued its Final Rule on the Conditions for Use

of Non-GAAP Financial Measures on January 24, 2003,

effective March 28, 2003. They adopted a new disclosure

regulation, Regulation G and amendments to Item 10 of

Regulation S-K, S-B, and Form 20-F to provide additional

guidance to public companies that report non-GAAP

financial measures in their SEC filings. A key provision

HENRY ET AL.115