Angela K. Davis

Emphasis on Pro Forma versus GAAP Earnings in Quarterly Press Releases: Determinants, SEC intervention, and Market Reactions

Earnings press releases provide managers a means to emphasize alternative earnings metrics and perhaps influence the perceptions of firm stakeholders. Recent accounting scandals heightened public scrutiny of accounting disclosures and prompted regulators to issue advice regarding the content and composition of firms’ earnings press releases. We explore the use of managerial emphasis as a disclosure tool and contribute to the current debate over pro forma earnings. Specifically, we examine (1) the determinants of emphasis placed on pro forma and GAAP earnings within quarterly earnings press releases, (2) whether there has been a shift away from (toward) emphasizing pro forma (GAAP) earnings, and (3) whether stock market reactions to earnings news were influenced by emphasis placed on metrics within the press release. We consider two measures of emphasis: the level of emphasis (based on where pro forma and GAAP earnings are mentioned in the press release) and relative emphasis (the difference in placement between pro forma and GAAP earnings). Our results are consistent with managers being strategic in their emphasis on alternative earnings metrics, suggesting that placement of metrics within the earnings release is neither random nor boilerplate. We find that firms focus on metrics that are more value-relevant and portray more favorable firm performance. We also find that the extent to which the firm’s press release is likely to be publicized in the news (i.e., the extent of media coverage) affects managers’ emphasis decision. Further, our results indicate a highly significant shift toward (away from) GAAP (pro forma) emphasis in 2002 relative to 2001. Finally, our stock market tests suggest that greater emphasis on pro forma or GAAP earnings in the quarterly press release results in a larger reaction to the news. Overall, these findings are consistent with managers using emphasis in the earnings press release as a disclosure tool and this emphasis influencing at least one important stakeholder group.

Beyond the Numbers: Measuring the Information Content of Earnings Press Release Language

Earnings press releases are the primary mechanism by which managers announce quarterly earnings and make other concurrent disclosures to investors and other stakeholders. A largely unexplored element of earnings press releases is the language that managers use throughout the press release, which we argue provides a unifying framework for these disclosures and an opportunity for managers to signal, both directly and more subtly, their expectations about future performance. We analyze the full texts of approximately 23,000 earnings press releases issued between 1998 and 2003 and examine whether the language used in these earnings press releases provides a signal about expected future firm performance and whether the market responds to this signal. Using categories derived from linguistic theory, we count words characterized as optimistic and pessimistic and construct a measure of managers’ net optimistic language for each earnings press release. We find that this measure is positively associated with future ROA and generates a significant market response in a short window around the earnings announcement date. We include in our models the earnings surprise as well as other quantifiable, concurrent disclosures identified in prior research as associated with the market’s reaction to earnings press releases. Our results support the premise that earnings press release language provides a signal regarding managers’ future earnings expectations to the market and that the market responds to this signal. We interpret our evidence to suggest that managers use language in earnings press releases to communicate credible information about expected future firm performance.

The Effect of Manager-Specific Optimism on the Tone of Earnings Conference Calls

The use of more or less positive language in corporate disclosures has been the subject of increased interest in the academic literature. We add to this stream of research by examining whether there is a manager-specific component in the tone of earnings-announcement related conference calls. We find that the tone of conference calls that is not explained by current performance, future performance, and strategic incentives has a significant manager-specific component. We also find that tone is significantly associated with manager-specific factors such as early career experiences and involvement in charitable organizations. Taken together, our findings indicate that, in addition to reflecting current and future performance, the tone of conference calls is significantly influenced by a manager-specific tendency to be optimistic or pessimistic. We also find some evidence of a manager-specific component to conference call returns, which is consistent with manager-specific optimism impacting investors’ interpretation of disclosures made in conference calls.

Disclosure and the Outcome of Securities Litigation

Abstract We examine the impact of disclosure by defendant firms on the outcome of securities fraud class actions. We hypothesize that firms issuing a higher quantity of disclosure will experience more adverse litigation outcomes, given the strict pleading standards of the Private Securities Litigation Reform Act (PSLRA). Using broad measures of disclosure derived from press releases issued during the class period, we find that more disclosure increases the likelihood that the judge will allow a lawsuit to proceed rather than dismissing it. Our results provide new insights to the literature on disclosure and litigation by studying the outcome rather than incidence of litigation, or the plaintiffs’ decision to sue. We strengthen the inference that the features of the PSLRA create a positive relationship between overall disclosure and the likelihood of settlement by showing that the relationship holds when controlling for forward-looking disclosure and ex ante litigation risk, and by providing evidence that more public disclosures allow plaintiffs to present more extensive cases.