The Relationship Between Non‐GAAP Earnings and Aggressive Estimates in Reported GAAP Numbers

• Published date: 01 December 2022
• Author: RYAN D. GUGGENMOS,KRISTINA RENNEKAMP,KATHY RUPAR,SEAN WANG
• Date: 01 December 2022
• DOI: http://doi.org/10.1111/1475-679X.12434

DOI: 10.1111/1475-679X.12434

Journal of Accounting Research

Vol. 60 No. 5 December 2022

Printed in U.S.A.

The Relationship Between

Non-GAAP Earnings and Aggressive

Estimates in Reported GAAP

Numbers

RYAN D. GUGGENMOS ,∗KRISTINA RENNEKAMP,∗

KATHY RUPAR,†AND SEAN WANG‡

Received 30 August 2019; accepted 17 March 2022

ABSTRACT

This study uses a controlled experiment to examine the trade-off between

managers’ use of non-GAAP and GAAP earnings to satisfy market expecta-

tions and how this relationship can be moderated by both formal and in-

formal regulatory attention to non-GAAP earnings. Our key takeaway is that

allowing financial reporting discretion in an alternative disclosure channel,

that is, non-GAAP earnings, can reduce firms’ opportunistic GAAP reporting.

However, statements by regulators about increased attention to non-GAAP

earnings constrain this channel, and this can result in more aggressive GAAP

earnings management and reduced GAAP earnings quality. We triangulate

these findings with a survey and archival analyses and find results that are

∗Cornell University; †Georgia Institute of Technology; ‡Southern Methodist University

Accepted by Rodrigo Verdi. Wethank the Associate Editor and an anonymous reviewer for

helpful comments throughout the review process. We also thank Scott Asay, Natasha Bern-

hardt, Rob Bloomfield, Tina Carpenter, Ted Christensen, Shannon Garavaglia, Jackie Ham-

mersley, Eric Hirst, Steve Kachelmeier, Lisa Koonce, Bob Libby, Mark Nelson, Mike Ricci,

Christy Sims, Blake Steenhoven, Brian White, and workshop participants at the University of

Bern, the East Coast Behavioral Accounting Workshop, the Georgia Institute of Technology,

the University of Georgia, and the University of Texasat Austin for their helpful comments on

the paper. Wethank Natasha Bernhardt and Peina Liu for research assistance. An online ap-

pendix to this paper can be downloaded at http://research.chicagobooth.edu/arc/journal-

of-accounting-research/online- supplements.

1915

© 2022 The Chookaszian Accounting Research Center at the University of Chicago Booth School of

Business.

1916 r. d. guggenmos, k. rennekamp, k. rupar, and s. wang

consistent with this primary message. Our study provides evidence relevant to

standard setters and regulators that non-GAAP measures may serve an impor-

tant role even if they can be used opportunistically.

JEL codes: G32, G41, H32, K22, M40, M41

Keywords: non-GAAP measures; earnings management; aggressive report-

ing; reconciliation

1. Introduction

Non-GAAP reporting is nearly ubiquitous. The Center for Audit Qual-

ity (CAQ) found that 94% of S&P 500 companies disclosed at least

one non-GAAP financial measure in their Q1 2020 earnings release

(CAQ [2020]). Archival research has found that non-GAAP earn-

ings are value-relevant (Brown and Sivakumar [2003]) and at-

tract investor attention (Bhattacharya et al. [2003], Lougee and

Marquardt [2004]). However, non-GAAP earnings are less regulated

than GAAP earnings, and firms may take advantage of the flexibility

allowed in these metrics (for a review, see Black et al. [2018]). As a con-

sequence, regulators and standard setters have recently focused attention

on the discretion available to managers reporting non-GAAP earnings

(PCAOB [2016]) and have addressed this topic when speaking to auditors,

issuers, and investors (White [2015, 2016]). Our study investigates how

managers’ disclosure of non-GAAP earnings, as well as formal or informal

regulatory attention to non-GAAP earnings disclosures, affect managers’

aggressiveness in GAAP reporting.

Managers want to convey their views on firm performance and have

strong incentives to satisfy market expectations. Prior papers examine how

managers use accrual and/or real earnings management to satisfy market

expectations (Ewert and Wagenhofer [2005], Wang and D’Souza [2006],

Cohen and Zarowin [2010], Zang [2012]). In addition to these strategies,

managers can report both GAAP and non-GAAP metrics to satisfy market

participants. This is in line with prior archival research in accounting that

recognizes these metrics as potential substitutes (Black et al. [2017]). Given

the lighter regulation and greater discretion available in non-GAAP, com-

pared to GAAP, earnings, managers may prefer to use non-GAAP earn-

ings disclosures to calibrate investors’ expectations instead of pursuing

accrual or real earnings management strategies. As a result, we predict

that managers are less likely to manage GAAP earnings to meet market

benchmarks when non-GAAP earnings are also disclosed. However, regula-

tors have increased their attention to non-GAAP earnings disclosures. This

could make the use of non-GAAP earnings to calibrate expectations less at-

tractive and make more traditional GAAP earnings management methods

relatively more attractive. Thus, we also predict that regulatory attention

to non-GAAP earnings, whether as formal attention from reconciliation

requirements or informal attention from regulators’ statements about