Ervin L. Black

Has the Regulation of Pro Forma Reporting in the US Changed Investors’ Perceptions of Pro Forma Earnings Disclosures?: REGULATION OF PRO FORMA REPORTING IN THE US

We explore whether investors’ perceptions of pro forma earnings numbers have changed following the regulation of pro forma reporting imposed by the Sarbanes�?Oxley Act of 2002 (SOX). First, we find that investors appear to pay more attention to pro forma earnings disclosures in the post�?SOX period, consistent with the notion that they perceive that regulation generally renders these disclosures more credible. Second, the results indicate that investors discount aggressive pro forma earnings reports in both periods. However, they appear to discount at least some potentially misleading pro forma earnings disclosures more in the post�?SOX period. Finally, our results imply that the regulation of pro forma reporting has increased the average quality of pro forma earnings disclosures by filtering out those that are most likely to be misleading. These results are consistent with the conclusions that (1) the quality of pro forma reporting has improved following SOX, and (2) investors’ perceptions of pro forma earnings metrics have changed in the post�?SOX regulatory environment.

Has the Regulation of Non-GAAP Disclosures Influenced Managers’ Use of Aggressive Earnings Exclusions?

The frequency of non-GAAP (or “pro forma”) reporting has continued to increase in the United States over the last decade, despite preliminary evidence that regulatory intervention led to a decline in non-GAAP disclosures. In particular, the Sarbanes–Oxley Act of 2002 (SOX) and Regulation G (2003) impose strict requirements related to the reporting of non-GAAP numbers. More recently, the Securities and Exchange Commission (SEC) has renewed its emphasis on non-GAAP reporting and declared it a “fraud risk factor.” Given the SEC’s renewed emphasis on non-GAAP disclosures, we explore the extent to which regulation has curbed potentially misleading disclosures by investigating two measures of aggressive non-GAAP reporting. Consistent with the intent of Congress and the SEC, we find some evidence that managers report adjusted earnings metrics more cautiously in the post-SOX regulatory environment. Specifically, the results suggest that firms reporting non-GAAP earnings in the post-SOX period are less likely to (a) exclude recurring items incremental to those excluded by analysts and (b) use non-GAAP exclusions to meet strategic earnings targets on a non-GAAP basis that they miss based on Institutional Brokers’ Estimate System (I/B/E/S) actual earnings. However, we also find that some firms exclude specific recurring items aggressively. Overall, the results suggest that while regulation has generally reduced aggressive non-GAAP reporting, some firms continue to disclose non-GAAP earnings numbers that could be misleading in the post-SOX regulatory environment.

The Effects of Executive Compensation Contracts and Auditor Effort on Pro Forma Reporting Decisions

We investigate two potential deterrents of aggressive pro forma reporting. First, the design of compensation contracts can encourage managers to adopt either a short- or a long-term focus. While it is difficult to observe whether compensation contracts are tied directly to pro forma earnings numbers, we posit that managers with a short-term horizon are more likely to make aggressive pro forma exclusions than managers with a long-term focus. Second, auditor effort can discourage potentially misleading pro forma earnings adjustments. Consistent with our predictions, we find that when compensation contracts include a long-term performance plan, managers are less likely to make potentially misleading pro forma earnings adjustments. Similarly, we find some evidence of a negative association between auditor effort (as proxied by higher-than-normal audit fees) and potentially misleading earnings adjustments. Taken together, this evidence is consistent with the notion that the design of compensation contracts and auditor effort can significantly influence managers’ pro forma reporting decisions. The results also suggest that investors discount earnings information when opportunism is likely to motivate managers’ earnings adjustments. Moreover, when managers make aggressive earnings exclusions in the presence of safeguards that limit opportunistic behavior, investors appear to react even more negatively.

The Use of Non-GAAP Performance Measures in Executive Compensation Contracting and Financial Reporting

We examine the relation between compensation incentives and non-GAAP earnings disclosures. Specifically, we focus on the extent to which bonus plan incentives and long-term performance plan incentives are associated with the aggressiveness of non-GAAP reporting, controlling for CEO sensitivity to stock price. Using a large hand-collected sample of non-GAAP earnings disclosures, we find that long-term plan incentives are negatively associated with the likelihood and magnitude of aggressive non-GAAP reporting, suggesting that they act as a deterrent to potentially opportunistic behavior. For a sub-sample of firms for which compensation contracts in proxy filings explicitly state that managers will be evaluated based on non-GAAP metrics, we find less opportunistic non-GAAP reporting, consistent with boards defining adjusted performance metrics in compensation contracts in order to limit CEOs’ ability to define their own non-GAAP numbers. However, when boards of directors have discretion to use non-GAAP metrics when evaluating managers, we find more opportunistic non-GAAP earnings reporting, consistent with managers using the flexibility in contracts to influence their performance evaluations.

The impact of IFRS on financial statement data in Greece

Purpose – The purpose of this paper is to examine the effects of IFRS adoption on financial statement data and their usefulness in Greece. Additionally, the authors examine the effect on the informativeness/usefulness of financial statement data for stock prices in Greece and the effect of the Greek Financial Crisis. Design/methodology/approach – This study examine the effects of IFRS adoption on financial statement data and their usefulness in Greece. Additionally, the authors examine the effect on the informativeness/usefulness of financial statement data for stock prices in Greece and the effect of the Greek Financial Crisis. Findings – The results indicate that several financial ratios were dramatically affected by IFRS adoption in Greece. In contrast to other countries, IFRS has not resulted in improved statistical behavior of these ratios in Greece: the ratios are highly skewed and the normality of their distribution is not improved. Additionally, when examining the usefulness of financial statement...

CEO Compensation Incentives and Non-GAAP Earnings Disclosures

We examine the relation between compensation incentives and non-GAAP earnings disclosures. Specifically, we focus on the extent to which bonus plan incentives and long-term performance plan incentives are associated with the aggressiveness of non-GAAP reporting, controlling for CEO sensitivity to stock price. Using a large hand-collected sample of non-GAAP earnings disclosures, we find that long-term plan incentives are negatively associated with the likelihood and magnitude of aggressive non-GAAP reporting, suggesting that they act as a deterrent to potentially opportunistic behavior. For a sub-sample of firms for which compensation contracts in proxy filings explicitly state that managers will be evaluated based on non-GAAP metrics, we find less opportunistic non-GAAP reporting, consistent with boards defining adjusted performance metrics in compensation contracts in order to limit CEOs’ ability to define their own non-GAAP numbers. However, when boards of directors have discretion to use non-GAAP metrics when evaluating managers, we find more opportunistic non-GAAP earnings reporting, consistent with managers using the flexibility in contracts to influence their performance evaluations.

The Use of Non-GAAP Performance Metrics for Compensation Contracting and Financial Reporting

We examine the relation between compensation incentives and non-GAAP earnings disclosures. Specifically, we focus on the extent to which bonus plan incentives and long-term performance plan incentives are associated with the aggressiveness of non-GAAP reporting, controlling for CEO sensitivity to stock price. Using a large hand-collected sample of non-GAAP earnings disclosures, we find that long-term plan incentives are negatively associated with the likelihood and magnitude of aggressive non-GAAP reporting, suggesting that they act as a deterrent to potentially opportunistic behavior. For a sub-sample of firms for which compensation contracts in proxy filings explicitly state that managers will be evaluated based on non-GAAP metrics, we find less opportunistic non-GAAP reporting, consistent with boards defining adjusted performance metrics in compensation contracts in order to limit CEOs’ ability to define their own non-GAAP numbers. However, when boards of directors have discretion to use non-GAAP metrics when evaluating managers, we find more opportunistic non-GAAP earnings reporting, consistent with managers using the flexibility in contracts to influence their performance evaluations.

How are Street Earnings Determined? Managers' Influence on Analysts' Exclusions and Agreement

We investigate how interactions between analysts and managers influence (1) analyst disagreement about the definition of forecasted street earnings and (2) shifts in the definition of actual street earnings. Textual analysis of conference call transcripts indicates that more discussion about non-GAAP earnings and exclusions is associated with larger street earnings exclusions, consistent with prior evidence that both managers and analysts influence street earnings. To measure disagreement among analysts about the definition of forecasted street earnings, we introduce a new measure based on the number of analysts whose forecasts are excluded from the consensus. We find that the discussion of non-GAAP earnings in the question and answer (Q&A) section of the conference call is significantly associated with this measure, indicating that the dialog between managers and analysts about non-GAAP performance metrics is associated with disagreement about how core performance should be defined. We also find that when more analysts are excluded from the consensus, the market response to positive earnings surprises is significantly muted, suggesting that analyst disagreement in defining performance influences a firm’s information environment. Finally, we employ three proxies to capture shifts in the consensus definition of actual street earnings and find that definition shifts are associated with both (1) manager-analyst non-GAAP discussions in conference calls and (2) our new proxy for analyst disagreement about the definition of street earnings. Our results provide a more comprehensive view of the roles played by managers and analysts in determining street earnings.

The effects of earnings and cash flow permanence on their incremental information content in Thailand

Abstract We examine whether the incremental information content of cash flows from operations (earnings) increases when earnings (cash flows) are transitory in Thailands emerging capital market. Prior research for developed capital markets (e.g. the United States and Japan) has found cash flows play a more important role in explaining security returns when earnings are transitory. The Stock Exchange of Thailand (“SET”) required listed firms to provide a Statement of Cash Flows beginning in 1994. This requirement was not in response to investor demand, but was motivated by the SETs desire to employ standards similar to those of developed markets. We find that for a sample of 448 firm-years between 1995 and 1997, cash flows have greater incremental information content and earnings have less information content when earnings are relatively transitory and cash flows are relatively permanent. When cash flows are relatively transitory, we find they have significantly less information content and earnings have significantly more.