Non-Gaap Earnings

Firms make non-GAAP (pro forma) adjustments to GAAP earnings for a variety of reasons. One of the possible motivations for pro forma adjustment is meet or beat analysts' expectations or to avoid earnings decrease. Bhattacharya et al. (2003) indicate that pro forma announcements may often be motivated by managers' desire to meet or beat analysts' expectations. They find that most pro forma announcements meet or beat analysts' mean forecasts, while only few of the GAAP operating earnings figures meet or beat analysts' mean forecasts. In addition, according to Bhattacharya et al. (2004), young firms that are concentrated primarily in the tech sector and business services industries tend to be announce pro forma earnings, and those firms are normally less profitable, high debt levels and P/E ratio. Thereby, managements seem to use pro forma earnings report to meet analysts' expectations and relieve negative earnings news which will have an overall negative effect on stock prices.

What is more, Bradshaw and Sloan (2002) suggest that street earnings number is the primary factor that determines stock prices rather than GAAP and more highly correlated with stock returns than GAAP based earnings. Therefore, managers and analysts may attempt to garner higher valuation by reporting the higher street earnings number in order to persuade investors to invest in their stock and increase investors' preference for their stock.

Moreover, Lougee and Marquardt (2004) report that firms that miss an earnings benchmark based on GAAP and firms with negative GAAP earnings surprises are more likely than other firms to provide pro forma earnings in their press releases.

As can be seen, most of the incentives likely to operate in the interests of investors because the value relevance of pro forma earnings appears to have increased significantly to book values and investors display an increasing preference for the pro forma earnings (Bradshaw and Sloan, 2002). Thus, both managers and analysts may have incentives for reporting non-GAAP (pro forma) earnings information in their press releases in order to meet or beat analysts' expectations or to avoid earnings decrease, attempt to garner higher valuation and try to give better portrays for firms that miss an earnings benchmark based on GAAP and firms with negative GAAP earnings surprises. Because pro forma earnings use to show core earnings of their company and they want to use these kinds of earnings to attract investors to invest in their company's stock.

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