Public announcements of firm’s earnings made by managers typically disclose more information than GAAP earnings (earnings calculated according to mandatory accounting rules or Generally Accepted Accounting Principles). Frequently managers choose to disclose other financial measures (referred to as Non-GAAP). An internal study by EFRAG (European Financial Reporting Advisory Group is an EU body for financial reporting issues) in 2006 finds that 68% top firms disclose non-GAAP measures in the U.K. That percentage is 62% for Germany and 76% for France. In the U.S. non-GAAP reporting is also a common practice (Marques, 2006). Managers argue that non-GAAP numbers represent the true permanent earnings of the firm which is not captured by the rigid GAAP rules. Critics of these numbers call it ‘earnings before the bad stuff’ and contra-argue that they mislead users of financial information. Academic research finds evidence of both hypotheses. Black and Christensen (2007) show that managers opportunistically choose non-GAAP measures while Brown and Sivakumar (2003) suggest that non-GAAP information is value relevant to investors.  

In the U.S. the voluntary disclosure of non-GAAP measures was regulated by the Securities and Exchange Commission (SEC) in 2003. The SEC intention was to reduce potentially misleading information. As a consequence the frequency of these disclosures decreased significantly (Marques 2006).  

In Europe, with the exception of the U.K., there are no rules on non-GAAP disclosure. In most European countries managers do not need to explain non-GAAP numbers suggesting that European managers’ have a higher degree of discretion over financial information than their US counterparts. A pilot study by Isidro and Marques (2008) indicates that non-GAAP disclosures are frequent in Europe and its content varies across firms and countries. Concerned about the lack of consistency and clarify of these measures European regulators are considering the introduction of regulation (EFRAG 2006). The financial press has also questioned the validity of these numbers (I.Wright PWC partner 2007), particularly after the introduction in Europe of the International Financial Reporting Standards (IFRS) issued by International Accounting Standard Board (IASB). They argue that IFRS complexity has boosted non-GAAP reporting and consequently managers’ discretion. Despite the concerns there is little academic investigation. The scarce research is not conclusive (Hitz 2009 finds low transparency in non-GAAP reporting in Germany, Choi et al 2007 show that management adjustments in the U.K. are value relevant), and there is no study addressing the determinants and market effects of the disclosure.  

A distinctive characteristic of the European setting compared to the U.S. is the (still) significant variation in institutional and firm conditions. For example La Porta et al. (2006) and the Federation of European Stock Exchanges (2006) illustrate the legal and ownership diversity across Europe. In summary, in Europe there is substantial institutional variation, differences in firms’ characteristics, almost no regulation on non-GAAP reporting, and new reporting rules (IFRS). Europe offers a unique scenario to study the reasons and consequences of voluntary disclosures of non-GAAP measures and how it interlinks with countries and firm factors. We expect to find that managers’ decisions and consequent market effects vary across firm (i.e. size, governance, and diversification) and jurisdictions (i.e. legal environment, market development). Our findings will contribute to the ongoing academic debate but also to inform regulators and market participants about the effects of non-GAAP reporting. The project benefits from a research team with unique expertise. Ana has developed research on non-GAAP in the U.S. and has skills in handling non-GAAP data (Marques, 2006). Helena has detailed knowledge of financial reporting in Europe, acquired from her research (Isidro et al 2006) and participation in EU Harmonia research project and EFRAG. 

The project proposes to investigate several issues. First, document the practice of non-GAAP reporting and how it varies across countries and firm characteristics. Second, investigate the determinants of managers’ decision to disclosure non-GAAP measures. Third, study whether such disclosure lead to less information asymmetry. Fourth, explore how markets access managers’ adjusted numbers. We tackle these issues empirically applying several econometric techniques (e.g. OLS, logit, selection models). We use hand-collected data for the top 500 European firms (another uniqueness of the project), for period 2003-2005 covering years before and after IFRS.  

Given the novelty of the project we expect to achieve four academic publications in leading journals and to present results in US and European top conferences. We will make use of Helena’s European links trough Harmonia project to present work in European universities too. 

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