Business Strategy and Non-GAAP Earnings Disclosure

This paper examines the influence of business strategy on firms’ discretionary disclosure of non-GAAP earnings. We find that innovation-oriented firms (i.e., prospectors) have a higher propensity of disclosing non-GAAP earnings, whereas efficiency-driven firms (i.e., defenders) are less likely to issue non-GAAP earnings. Subsequent tests reveal that the prospector managers are more likely to disclose non-GAAP earnings to “convert” GAAP losses into non-GAAP profit and “meet and beat” analyst forecast, consistent with managers’ opportunistic use of non-GAAP earnings as a strategic device to engage in impression management. To corroborate the managerial opportunism behind non-GAAP earnings disclosure, we test the predictability of non-GAAP exclusions and find that the managerial exclusions are of low quality in predicting future GAAP earnings and future cash flows. Cross-sectional analyses indicate that the positive relationship between business strategy and the likelihood of pro forma earnings disclosure is more pronounced amongst firms with higher levels of prior accruals management, firms facing higher agency costs, and firms with higher managerial ability. By exploiting the exogenous shocks that significantly reduce talent supply and fundamentally undermine prospectors’ viability of pursuing an innovation-oriented business strategy, our triple-differences (DiDiD) analysis shows that prospectors significantly restrain the use of non-GAAP earnings following the staggered adoptions of Inevitable Disclosure Doctrine. Our results are robust to a battery of robustness tests including propensity-score-matching (PSM) technique, entropy balancing approach, an instrumental variable (IV) approach, and the inclusion of individual business strategy components. Overall, our study sheds light on the role of business strategy as an intrinsic and longstanding firm characteristic, in shaping corporate decisions on the discretionary disclosure of non-GAAP earnings.