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US Managers' Use of ‘Pro Forma’ Adjustments to Meet Strategic Earnings Targets

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  • Dirk E. Black
  • Theodore E. Christensen
Abstract
The practice of reporting manager‐adjusted ‘pro forma’ earnings numbers in quarterly earnings press releases has attracted considerable attention in recent years in the United States. Prior research suggests that while some managers report these adjusted numbers to better reflect core earnings, others may use these earnings adjustments to meet strategic earnings targets on a pro forma basis when they fall short based on GAAP reporting standards. Assuming the latter motivation could potentially mislead investors, the difficulty lies in distinguishing the ‘good guys’ from the ‘bad guys.’ Using hand‐collected pro forma earnings data, we investigate the extent to which different types of earnings adjustments affect the spread between pro forma earnings and GAAP earnings from continuing operations. Moreover, we investigate which types of adjustments managers use to meet strategic earnings targets. In addition to the exclusion of one‐time items like restructuring charges, the results indicate that managers often exclude recurring expenses such as depreciation, research and development, and stock‐based compensation to meet these strategic targets. The exclusion of recurring items is especially indicative of aggressive pro forma reporting. Finally, we find that firms that report adjusted earnings numbers only sporadically are more likely than firms that adjust earnings figures on a regular basis to use pro forma reporting to achieve strategic earnings targets by excluding recurring items.

Suggested Citation

  • Dirk E. Black & Theodore E. Christensen, 2009. "US Managers' Use of ‘Pro Forma’ Adjustments to Meet Strategic Earnings Targets," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(3‐4), pages 297-326, April.
    • Handle: RePEc:bla:jbfnac:v:36:y:2009:i:3-4:p:297-326
    DOI: 10.1111/j.1468-5957.2009.02128.x
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    References listed on IDEAS

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    1. Wayne R. Landsman & Bruce L. Miller & Shu Yeh, 2007. "Implications of Components of Income Excluded from Pro Forma Earnings for Future Profitability and Equity Valuation," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 34(3-4), pages 650-675.
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    3. Jeffery S. Abarbanell & Reuven Lehavy, 2007. "Letting the “Tail Wag the Dog†: The Debate over GAAP versus Street Earnings Revisited," Contemporary Accounting Research, John Wiley & Sons, vol. 24(3), pages 675-723, September.
    4. Wayne R. Landsman & Bruce L. Miller & Shu Yeh, 2007. "Implications of Components of Income Excluded from Pro Forma Earnings for Future Profitability and Equity Valuation," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 34(3‐4), pages 650-675, April.
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    6. Bhattacharya, Nilabhra & Black, Ervin L. & Christensen, Theodore E. & Larson, Chad R., 2003. "Assessing the relative informativeness and permanence of pro forma earnings and GAAP operating earnings," Journal of Accounting and Economics, Elsevier, vol. 36(1-3), pages 285-319, December.
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    3. Theodore E. Christensen & Hang Pei & Spencer R. Pierce & Liang Tan, 2019. "Non-GAAP reporting following debt covenant violations," Review of Accounting Studies, Springer, vol. 24(2), pages 629-664, June.
    4. Florian Meier, 2020. "The Age of Cheap Money and Passive Investing: Are Pro Forma Earnings Value Relevant?," Journal of Finance and Investment Analysis, SCIENPRESS Ltd, vol. 9(2), pages 1-1.
    5. Claudia Arena & Simona Catuogno & Nicola Moscariello, 2021. "The unusual debate on non-GAAP reporting in the current standard practice. The lens of corporate governance," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 25(3), pages 655-684, September.
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    7. Ting Zhang & So Yean Kwack & Yi Si & Gaoliang Tian, 2023. "Non‐GAAP earnings reporting following going‐concern opinions," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(3), pages 3217-3252, September.
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    9. Kyung, Hangsoo & Lee, Hakyin & Marquardt, Carol, 2019. "The effect of voluntary clawback adoption on non-GAAP reporting," Journal of Accounting and Economics, Elsevier, vol. 67(1), pages 175-201.
    10. Charitou, Andreas & Floropoulos, Nikolaos & Karamanou, Irene & Loizides, George, 2018. "Non-GAAP Earnings Disclosures on the Face of the Income Statement by UK Firms: The Effect on Market Liquidity," The International Journal of Accounting, Elsevier, vol. 53(3), pages 183-202.
    11. Jason V. Chen & Kurt H. Gee & Jed J. Neilson, 2021. "Disclosure Prominence and the Quality of Non‐GAAP Earnings," Journal of Accounting Research, Wiley Blackwell, vol. 59(1), pages 163-213, March.
    12. Mariela Carvajal & David H. Lont & Tom Scott, 2022. "Non‐GAAP Earnings Disclosure Trends in New Zealand," Australian Accounting Review, CPA Australia, vol. 32(1), pages 19-35, March.
    13. Steven Young, 2014. "The drivers, consequences and policy implications of non-GAAP earnings reporting," Accounting and Business Research, Taylor & Francis Journals, vol. 44(4), pages 444-465, August.
    14. Ahmed M. Elnahas & Pankaj K. Jain & Thomas H. McInish, 2022. "Mixed‐signal stock splits," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 49(5-6), pages 934-962, May.
    15. Mark Brosnan & Keith Duncan & Tim Hasso & Janice Hollindale, 2023. "Non‐GAAP earnings and executive compensation: An experiment," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(4), pages 4375-4398, December.
    16. Bradshaw, Mark T. & Christensen, Theodore E. & Gee, Kurt H. & Whipple, Benjamin C., 2018. "Analysts’ GAAP earnings forecasts and their implications for accounting research," Journal of Accounting and Economics, Elsevier, vol. 66(1), pages 46-66.
    17. Nilabhra Bhattacharya & Theodore E. Christensen & Qunfeng Liao & Bo Ouyang, 2022. "Can short sellers constrain aggressive non-GAAP reporting?," Review of Accounting Studies, Springer, vol. 27(2), pages 391-440, June.
    18. Chen, Xia & Jiang, Xuejun & Lu, Louise Yi & Yu, Yangxin, 2021. "Local political corruption and Firm's non-GAAP reporting," Journal of Corporate Finance, Elsevier, vol. 70(C).
    19. Oded Rozenbaum, 2019. "EBITDA and Managers' Investment and Leverage Choices," Contemporary Accounting Research, John Wiley & Sons, vol. 36(1), pages 513-546, March.
    20. Cao Hoang Anh Le & Yaowen Shan & Stephen Taylor, 2020. "Executive Compensation and Financial Performance Measures: Evidence from Significant Financial Institutions," Australian Accounting Review, CPA Australia, vol. 30(3), pages 159-177, September.
    21. Novia (Xi) Chen & Peng-Chia Chiu & Terry Shevlin & Jiani Wang, 2023. "Taxes in Non-GAAP Reporting: Evidence of Strategic Behavior in Selecting Tax Rates Applied to Exclusions," Management Science, INFORMS, vol. 69(5), pages 3100-3120, May.
    22. Chen, Han-Chung & Lee, Yen-Jung & Lo, Sheng-Yi & Yu, Yong, 2021. "Qualitative characteristics of non-GAAP disclosures and non-GAAP earnings quality," Journal of Accounting and Economics, Elsevier, vol. 72(1).

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