An analysis of non-GAAP financial metrics

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School of Business | Master's thesis
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As non-GAAP financial reports have proliferated in the last three decades, market participants have begun to question the accuracy and credibility of non-GAAP information, particularly in the context of equity valuation. On the one hand, companies’ managers claim that non-GAAP earnings metrics have important value implication for investors as it can reduce ”accounting noises” and reveal relevant insider information that might be neglected through standardized recording systems like GAAP. On the other hand, market regulations and researchers are more critical towards nonGAAP metrics, criticizing that non-GAAP exclusions are more than relevant and excluding them will yield misleading and inaccurate information. This empirical study, therefore, firstly aims to examine the development of non-GAAP financial metrics both in term of frequency of publication and magnitude of non-GAAP exclusions. In the period from 2003 to 2015, the amount of nonGAAP earnings reports has doubled and the gap between non-GAAP and GAAP metrics has become larger, indicating managers have become more aggressive in their non-GAAP reporting. Secondly, in attempt to identify the key drivers behind the difference between GAAP and nonGAAP earnings metrics (non-GAAP exclusions), we find that special items are strongly correlated to non-GAAP exclusions, suggesting that managers are more likely to exclude special items to come to better earnings numbers. One interesting finding is that cost of goods sold and selling, and general administration expenses also have strong links to non-GAAP exclusions. One possible explanation is that as managers exhaust in choices of exclusions, they will resort to less obvious options; that would be more likely to yield flawed and inaccurate financial information.
Thesis advisor
Jarva, Henry
non-GAAP, pro forma, non-GAAP adjustments, special items, exclusions, GAAP
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