The use of non‐GAAP measures in initial public offerings

• Author: Bo Liu,Dana Zhang
• DOI: http://doi.org/10.1002/jcaf.22463
• Published date: 01 October 2020
• Date: 01 October 2020

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The use of non-GAAP measures in initial public offerings

Bo Liu PhD|Dana Zhang PhD

Sigmund Weis School of Business,

Susquehanna University, Selinsgrove,

Pennsylvania

Correspondence

Dana Zhang, Sigmund Weis School of

Business, Susquehanna University,

Selinsgrove, PA.

Email: zhangd@susqu.edu

Abstract

This study examines the use of non-GAAP measures (NGMs) in initial public

offerings (IPOs). Based on NGMs collected for a sample of 300 IPO firms from

2009 to 2013, we find that 60% of IPO firms disclose NGMs in their registration

filings. While a variety of NGMs are used, earnings before interest, tax, depre-

ciation, and amortization (EBITDA) and adjusted EBITDA are the most fre-

quently reported NGMs. The vast majority of the reported NGMs are greater

than the firms' GAAP earnings. The results also show that IPO firms are more

likely to disclose NGMs when their GAAP earnings are close to benchmarks,

when they report special items, and when they have a higher proportion of

intangible assets. In addition, the likelihood of reporting NGMs decreases for

IPO firms with high R&D expenditures.

KEYWORDS

initial public offering, non-GAAP measures

1|INTRODUCTION

As alternative earnings measures voluntarily disclosed by

firms, non-GAAP measures (NGMs) have become

increasinglypopularoverthelast20 years(Black&

Christensen, 2018). While firms typically claim “such

tailor-made metrics are a way for investors to better

understand their business”(Maurer, 2019), the SEC has

expressed concerns about NGMs being potentially mis-

leading and has implemented the Regulation G in 2003,

which requires the reconciliation of NGMs with the

GAAP earnings. Despite the controversy around the use

of NGMs, disclosing such adjusted earnings numbers has

become a widespread practice (PwC, 2019). Understand-

ing how and when companies report NGMs can help the

investors and regulators assess the motivations and

incentives behind the use of such measures.

This study focuses on NGM reporting in the IPO pro-

spectus. Initial public offering is one of the most promi-

nent corporate events in a company's history, and the

IPO prospectus (S-1 filing) plays an important role in

shaping investors' perceptions and valuations of a com-

pany. Despite the potentially significant impact of the

IPO prospectus, there are little empirical evidence on the

use of NGMs in IPOs.

Prior studies on NGMs typically focus on the use of

NGMs in periodic earnings announcements. In general,

these studies offer two types of explanations for NGM

reporting. One argument is that managers disclose NGMs

because they want to exclude transitory items and report

core earnings that are more value relevant to investors.

Consistent with this view, researchers find that NGMs are

sometimes more persistent than GAAP earnings and some

investorsrelyonNGMsmorethanGAAPearnings

(Bhattacharya,Black,Christensen,&Larson,2003;

Bradshaw & Sloan, 2002; Brown & Sivakumar, 2003). The

other argument is that managers are self-serving and dis-

close NGMs opportunistically to present rosier performance

to investors. Consistent with this argument, researchers

document that some managers exclude recurring expenses

such as R&D and stock compensation expenses, exclude

only transitory losses but not transitory gains, and use

NGMs to meet analyst expectations (Barth, Gow, & Taylor,

2012; Black & Christensen, 2009; Brown, Christensen,

Elliott, & Mergenthaler, 2012; Curtis, McVay, & Whipple,

2014; Doyle, Jennings, & Soliman, 2013).

Received: 23 March 2020Revised: 29 June 2020Accepted: 7 July 2020

DOI: 10.1002/jcaf.22463

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