Earnings Informativeness and Strategic Disclosure: An Empirical Examination of “Pro Forma” Earnings

2004 ◽  
Vol 79 (3) ◽  
pp. 769-795 ◽  
Author(s):  
Barbara A. Lougee ◽  
Carol A. Marquardt
Keyword(s):  
Market Efficiency ◽  
Predictive Ability ◽  
Press Releases ◽  
Empirical Examination ◽  
Strategic Disclosure ◽  
Earnings Information ◽  
Pro Forma Earnings ◽  
Earnings Informativeness ◽  
Earnings Surprises ◽  
Pro Forma

This paper provides evidence on the characteristics of firms that include “pro forma” earnings information in their press releases, whether the usefulness of pro forma earnings to investors varies systematically with these characteristics, and whether the investor response to pro forma earnings is consistent with market efficiency or mispricing. Using a sample of 249 press releases from 1997–99, we find that firms with low GAAP earnings informativeness are more likely to disclose pro forma earnings than other firms. We also find that strategic considerations, measured using the direction of GAAP earnings surprises, are an important determinant of pro forma reporting. In addition, our examination of the relative and incremental information content of pro forma earnings shows that investors find pro forma earnings to be more useful when GAAP earnings informativeness is low or when strategic considerations are absent. Tests of the predictive ability of pro forma earnings for future profitability and returns are mixed, and we therefore cannot conclusively determine whether the investor reaction to pro forma earnings at the time of the press release is consistent with market efficiency or mispricing. The paper contributes to the growing literature on pro forma earnings and more generally to the literature on voluntary and strategic disclosure.

scholarly journals Who Trades on Pro Forma Earnings Information?

2007 ◽  
Vol 82 (3) ◽  
pp. 581-619 ◽  
Author(s):  
Nilabhra Bhattacharya ◽  
Ervin L. Black ◽  
Theodore E. Christensen ◽  
Richard D. Mergenthaler
Keyword(s):  
Individual Investors ◽  
Press Releases ◽  
Earnings Surprise ◽  
Earnings Information ◽  
Pro Forma Earnings ◽  
Sarbanes Oxley ◽  
Core Earnings ◽  
Earnings Disclosures ◽  
Pro Forma ◽  
Financial Press

In recent years, many companies have emphasized adjusted-GAAP earnings numbers in their quarterly press releases. While managers use different names to describe these nonstandard earnings metrics, the financial press frequently refers to them as “pro forma” earnings. Managers and other advocates of pro forma reporting argue that these disclosures provide a clearer picture of companies' core earnings. On the other hand, regulators, policymakers, and the financial press often allege that managers' pro forma earnings disclosures are opportunistic attempts to mislead investors. Recent evidence suggests that while many pro forma earnings disclosures are altruistically motivated, some may represent managers' attempts to portray overly optimistic financial performance. If this is the case, then less wealthy, less sophisticated, individual investors are arguably the most at risk of being misled. Consequently, this study investigates who trades on pro forma earnings information. Our intraday investigation of transactions around earnings announcements containing pro forma earnings information reveals that less sophisticated investors' announcement-period abnormal trading is significantly positively associated with the magnitude and direction of the earnings surprise based on pro forma earnings. In contrast, we find no association between sophisticated investors' trading and manager-reported pro forma information. Overall, our analyses and numerous robustness tests suggest that the segment of the market that relies on pro forma earnings information is populated predominantly by less sophisticated individual investors. This evidence is particularly relevant to standard-setters and regulators given that Section 401(b) of the Sarbanes-Oxley Act of 2002 and subsequent SEC regulations are specifically designed to protect ordinary investors from misleading pro forma information.

Pro Forma Earnings Presentation Effects and Investment Decisions

2017 ◽  
Vol 29 (2) ◽  
pp. 11-24 ◽  
Author(s):  
Brian R. Hogan ◽  
Ganesh Krishnamoorthy ◽  
James J. Maroney
Keyword(s):  
Investment Decisions ◽  
Performance Assessments ◽  
Data Availability ◽  
Future Research ◽  
Earnings Information ◽  
Pro Forma Earnings ◽  
Income Statement ◽  
Earnings Performance ◽  
The Difference ◽  
Pro Forma

ABSTRACT Reacting to the criticism that companies routinely mislead investors by emphasizing non-GAAP or pro forma numbers, the SEC promulgated Regulation G in 2003, which requires firms to provide a reconciliation of the pro forma and GAAP numbers. In this study, we conduct an experiment to examine how investors' GAAP and non-GAAP earnings performance assessments affect their financial evaluations and investment decisions based on the presentation format of the reconciliation (presenting a full non-GAAP income statement, referred to as the full NGIS format, versus presenting only the items that caused the difference between GAAP and non-GAAP measures, referred to as the summary NGIS format). We find that even though a summary NGIS format for the reconciliation of pro forma earnings does not increase the perceived non-GAAP earnings performance, it does increase the weight given to non-GAAP earnings performance when making investment-related judgments and decisions, relative to a full NGIS format. These findings regarding the evaluation and weighting of non-GAAP earnings performance extend prior studies and suggest that non-GAAP earnings information may be processed differently based upon the format of the reconciliation. Further, our finding regarding the weighting of non-GAAP earnings performance is inconsistent with the concern expressed by the SEC that the full NGIS format may give greater prominence to non-GAAP information. Finally, the implications of these findings for regulators, investors, and future research are discussed. Data Availability: Contact the authors.

eToys Inc.: A Case Examining Pro Forma Financial Reports, Analysts' Forecasts, and Going Concern Disclosures

2003 ◽  
Vol 18 (2) ◽  
pp. 191-209 ◽  
Author(s):  
Iris C. Stuart ◽  
Vijay Karan
Keyword(s):  
Financial Statements ◽  
Financial Information ◽  
Press Releases ◽  
Financial Reports ◽  
The Public ◽  
Going Concern ◽  
Pro Forma Earnings ◽  
Financial Disclosures ◽  
The Impact ◽  
Pro Forma

This case is designed to provide you with the opportunity to examine several reporting issues, in the period between an IPO and bankruptcy filing, for a “dotcom” company that failed. You will consider the information provided to outside users of financial statements in several company reporting mechanisms including the financial disclosures made by the company in its 10-Q and 10-K filings to the SEC, the pro forma earnings reported in press releases, and the information available to the public to evaluate a going concern assumption. Further, you will also examine the impact of analysts' forecasts on management's release of financial information to the public.

Misleading Disclosure of Pro Forma Earnings: An Empirical Examination

2006 ◽  
Vol 69 (4) ◽  
pp. 355-372 ◽  
Author(s):  
Gary Entwistle ◽  
Glenn Feltham ◽  
Chima Mbagwu
Keyword(s):  
Empirical Examination ◽  
Pro Forma Earnings ◽  
Pro Forma

The Impact of Graphical Displays of Pro Forma Earnings Information on Professional and Nonprofessional Investors' Earnings Judgments

2012 ◽  
Vol 25 (1) ◽  
pp. 37-60 ◽  
Author(s):  
William N. Dilla ◽  
Diane J. Janvrin ◽  
Cynthia Jeffrey
Keyword(s):  
Data Availability ◽  
Fiscal Year ◽  
Nonprofessional Investors ◽  
Earnings Information ◽  
Graphical Displays ◽  
Pro Forma Earnings ◽  
Presentation Formats ◽  
Earnings Performance ◽  
The Impact ◽  
Pro Forma

ABSTRACT: Regulation G (SEC 2003b) requires managers to reconcile textual non-GAAP performance measures (i.e., pro forma disclosures) to GAAP. Graphical disclosures also require reconciliation; however, neither the format nor the placement of the reconciliation is specified. We apply cognitive fit theory to argue that the influence of graphical information presentation formats is contingent on investor type and judgment complexity. Participants in our study viewed a simulated Investor Relations website for a large drug retailer and made judgments regarding current fiscal year earnings performance, earnings potential, and investment amount. We manipulated graphical (GAAP-only versus GAAP and pro forma) and textual (GAAP-only versus pro forma reconciled to GAAP) earnings disclosure content in a 2 × 2 between-participants design. We find that nonprofessional investors' current fiscal year earnings performance, earnings potential, and investment amount judgments are all influenced by graphical displays, which include pro forma as opposed to GAAP-only earnings information. Graphical displays of pro forma earnings information do not influence professional investors' current year earnings performance judgments; however, these displays do influence professional investors' earnings potential and investment amount judgments because they are more complex. Our results suggest a need to further examine the influence of graphical pro forma earnings presentation formats on investor judgments. Data Availability: Contact the first author.

The Effects of Pro Forma Earnings Disclosures on Analysts' and Nonprofessional Investors' Equity Valuation Judgments

2004 ◽  
Vol 79 (3) ◽  
pp. 667-686 ◽  
Author(s):  
James R. Frederickson ◽  
Jeffrey S. Miller
Keyword(s):  
Stock Price ◽  
Cash Flows ◽  
Earnings Announcement ◽  
Nonprofessional Investors ◽  
Earnings Information ◽  
Pro Forma Earnings ◽  
Performance Metric ◽  
Earnings Disclosures ◽  
A Company ◽  
Pro Forma

This paper presents an experiment that examines the effect of pro forma earnings disclosures on the judgments of analysts (i.e., more sophisticated investors) and nonprofessional (i.e., less sophisticated) investors. In the experiment, participants developed stock price assessments after reviewing background financial information and a current earnings announcement for a company. The earnings announcement was manipulated to report only GAAP earnings in one condition and both pro forma and GAAP earnings in the other condition. Consistent with empirical evidence, the pro forma earnings in our experiment exceeded GAAP earnings. The results indicate that nonprofessional investors who received an earnings announcement that contained both pro forma and GAAP disclosures assessed a higher stock price than did nonprofessionals who received an announcement containing only GAAP disclosures. Financial analysts' stock price judgments were not affected by the pro forma disclosures. Followup analyses suggest that analysts and nonprofessional investors used different valuation models and information processing. Analysts used well-defined valuation models, based on either earnings-multiples or cash flows, while the nonprofessional investors were more likely to use simpler, heuristic-based valuation models. The pro forma disclosure did not cause nonprofessional investors to assess a higher earnings number for determining a stock price, but rather caused nonprofessionals to perceive the earnings announcement as more favorable, which in turn caused them to convert earnings or some other performance metric into a higher stock price. This effect appears to be due to unintentional cognitive effects, rather than nonprofessionals relying on pro forma earnings information because they perceived it to be informative.

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

2005 ◽  
Vol 80 (4) ◽  
pp. 1011-1038 ◽  
Author(s):  
Robert M. Bowen ◽  
Angela K. Davis ◽  
Dawn A. Matsumoto
Keyword(s):  
Stock Market ◽  
Media Coverage ◽  
Press Release ◽  
Significant Shift ◽  
Press Releases ◽  
Market Reactions ◽  
Pro Forma Earnings ◽  
Stock Market Reactions ◽  
Earnings Press Releases ◽  
Pro Forma

Earnings press releases provide managers a forum to present their firm's quarterly financial information and perhaps influence perceptions of the firm's stakeholders. We explore the use of managerial emphasis as a disclosure tool and contribute to the debate over pro forma earnings. 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 emphasizing pro forma earnings toward GAAP earnings, and (3) whether stock market reactions to earnings news were influenced by emphasis placed on metrics within the press release. We find that firms emphasize metrics that are more value-relevant and portray more favorable firm performance. We also find that the extent of a firm's media coverage affects managers' emphasis decisions. Further, our results indicate a highly significant shift toward GAAP emphasis and away from pro forma emphasis in 2002 relative to 2001. Finally, our stock market tests suggest that greater emphasis on an earnings metric results in a stronger market reaction to the surprise in that metric. 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—investors.

Empirical Evidence on Recent Trends in Pro Forma Reporting

2004 ◽  
Vol 18 (1) ◽  
pp. 27-43 ◽  
Author(s):  
Nilabhra Bhattacharya ◽  
Ervin L. Black ◽  
Theodore E. Christensen ◽  
Richard D. Mergenthaler
Keyword(s):  
Empirical Evidence ◽  
Press Releases ◽  
Business Services ◽  
Large Sample ◽  
Young Firms ◽  
Pro Forma Earnings ◽  
Income Statement ◽  
Recent Trends ◽  
Pro Forma ◽  
Debt Levels

This study provides descriptive evidence on the controversial trend adopted by many firms in recent years of reporting earnings figures on a pro forma basis. pro forma earnings exclude normal income statement items that managers deem to be nonrecurring or nonrepresentative of ongoing operations. We examine a large sample of actual pro forma press releases issued between January 1998 and December 2000. We find that pro forma announcers tend to be relatively “young” firms that are concentrated primarily in the tech sector and business services industries, and that they are significantly less profitable, more liquid, and have higher debt levels, P-E ratios, and book-to-market ratios than other firms in their own industries. Our results indicate that while firms commonly exclude multiple expenses in arriving at their pro forma earnings figure, they usually do not exclude the same items in subsequent pro forma announcements. These results support the criticism that pro forma announcements are often motivated by managers' desires to meet or beat analysts' expectations or to avoid earnings decreases.

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