Article

Impression Management and Non-GAAP Disclosure in Earnings Announcements

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Abstract

We study the market's reaction to the disclosure of non-GAAP earnings measures that are combined with high impression management. We construct an impression management score that captures several communication techniques that managers often use to positively bias investors' perceptions of firm performance. We hand-collect and code both quantitative and qualitative information from earnings announcement press releases of large European firms. Our results indicate that non-GAAP measures are informative to capital markets. However, non-GAAP adjustments are more persistent when accompanied by higher levels of impression management. This evidence is consistent with managers attempting to distort users' perceptions when non-GAAP adjustments are of lower quality. Market reaction tests suggest that investors are able to see through managers' intentions and discount non-GAAP information that is accompanied by high impression management. Moreover, investors in more sophisticated markets penalize non-GAAP measures communicated with high impression management. Our results are robust to a battery of sensitivity tests, including the use of a machine-coded tone measure.

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... Recently, there has been a global concern for environmental issues, and as a developing country, Bangladesh is no exception. Economic liberation and deregulation of industries have created more awareness among the Bangladeshi nation concerning environmental issues; therefore, we may expect that there is increased disclosure of environmental information in companies' websites and annual reports to gain organizational legitimacy (Guillamon-Saorin et al., 2017;Joshi et al., 2011). Legitimacy theory can be categorized from two different perspectives: strategic and institutional. ...
... Legitimacy offers inspiration to the firms to maintain a reputed position and status in the society and to feel the reactions of observant from the society (Kaium Masud et al., 2017) to legitimacy pressure; companies tend to disclose positive rather than negative information. As a part of legitimacy, environmental disclosures act as an influential catalyst of a company to share a strong and credible relationship with society (Comyns, 2016;Gregory et al., 2016;Guillamon-Saorin et al., 2017;Hossain et al., 2020;Luo and Tang, 2014;Masud et al., 2018;Nurunnabi, 2016). Therefore, both developed and developing countries are now reporting their environmental performance in their annual reports, websites and other forms of publications to mitigate legitimacy pressure vested upon them and to improve public perception (Gregory et al., 2016;Hahn and L€ ulfs, 2014;Yingjun et al., 2015). ...
... The study follows the content analysis method to meet the answer of the first three research questions as the content analysis method is a popularly used method in earlier disclosurebased studies (Bose et al., 2018;Chowdhury et al., 2020;Guillamon-Saorin et al., 2017;Kaium Masud et al., 2017;Singh and Kansal, 2011). For the first research question, the space incidence method was used, taking a sentence as a unit of analysis for measuring environmental disclosures in measuring disclosures. ...
Article
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Purpose The study seeks to evaluate the extent and quality of environmental reporting following a longitudinal analysis and covering a wide spectrum of industries in a single frame. The study also attempts to identify the set of most favored environmental reporting items by firms and items which are least disclosed. Furthermore, the study attempts to test whether certain corporate attributes such as firm size, age of the firm, leverage ratio, profitability, presence of independent directors in the board and gender diversity have any influencing power over environmental disclosure practices. The whole study has been carried out from legitimacy theory setting. Design/methodology/approach The study follows longitudinal analysis to identify the extent and quality of environmental disclosures. A self-constructed checklist of 12 environmental reporting items has been developed analyzing the annual report and content analysis method is followed to measure the extent and quality of environmental disclosures and identify environmental reporting items which are mostly disclosed and which are least disclosed. The study further uses panel data regression analysis to investigate whether certain corporate attributes have any impact on environmental disclosures using multiple linear regression. Total of 345 annual reports of listed financial and nonfinancial institutions have been observed in this study ranging from 2015 to 2019. Findings The key finding suggests that strict enforcement of Green Banking Rules 2011 fosters country’s commercial banks to invest more to protect the environment and commercial banks encourage nonfinancial institutions for environmental performance and related disclosures through finance. Therefore, almost 50% of sample firms disclose their environmental performance through reporting in either narrative, quantitative or monetary format which was only 2.23% in the last decade. Findings also reveal that tree plantation is the most reported environment disclosure followed by investment in renewable energy and green infrastructural projects and the least reported items are fund allocation for climatic changes and carbon management policy. Further analysis shows that firm size and leverage ratio both have positive impact on environmental reporting. Research limitations/implications An in-depth analysis may be conducted to identify why certain environmental items are least disclosed such as fund allotment for climatic changes, carbon management policy, etc. and how corporations may earn social appreciation and motivation by investing in those least preferred items in legitimacy theory setting. Future research may also take into consideration other corporate attributes which are not considered in the study. Originality/value The study conducted an in-depth analysis to understand the most favored form of environmental disclosures (narrative/quantitative/monetary) and their extent after incorporation of regulatory guidelines, which is the first of its kind in the research of environmental disclosures. The study indeed contributes to the documentation of environmental reporting in the context of a developing country where there is a lack of longitudinal analysis from the lens of legitimacy theory. Moreover, a wide spectrum of industries has been taken into consideration which facilitates the generalized findings on the environmental disclosure practices of corporations in Bangladesh.
... We measure tone manually. Manual analysis of text is more detailed (Brennan et al., 2009) and more flexible (Guillamon-Saorin et al., 2017) than automated techniques. It can be criticised as being subjective (Brennan et al., 2009). ...
... It can be criticised as being subjective (Brennan et al., 2009). Following the framework established in impression management studies (García Osma & Guillamón-Saorín, 2011;Guillamon-Saorin et al., 2017;Melloni et al., 2016) and relying on previous research in manual text analysis (Krippendorff, 2018), we develop a coding procedure and instructions to ensure the reliability and validity of coding. We carry out the coding ourselves. ...
Article
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This paper aims to identify the drivers of management reporting choices in a setting characterized by ownership concentration and weak enforcement. Previous research indicates, that tone of the letter to shareholders is correlated with performance. However, tone can be biased towards the positive when a company is highly responsive to stock market incentives or controlled by majority investors. Bias can be reduced by the monitoring activities of institutional investors in closely held companies. There are two major implications of the study. First, when managers bias the text, they lose the ability to communicate positive news about their company. Under rational expectations investors can detect bias based on known situational incentives and disregard the biased information. Second, the results suggest that managers manipulate tone strategically, rather than unconsciously, to satisfy the needs of key shareholder groups.
... Second, we only focus on one specific non-GAAP disclosure item, which makes our study narrower but allows for a more detailed analysis of EBITDA-related disclosures. Finally, we contribute to Guillamon-Saorin, Isidro and Marques (2017) who document that managers attempt to distort investors' perceptions of performance when non-GAAP disclosures are of a lower quality. As these researchers do not explicitly focus on EBITDA, our findings of more opportunistic behavior in case of adjusted EBITDA figures and less of such behavior for EBIT and EBITA disclosures, are very much consistent with their conclusions and extend their empirical findings. ...
... They find stronger evidence in countries with larger equity markets, stronger legal efficiency and better investor protection. In a related paper, Guillamon-Saorin, Isidro and Marques (2017) investigate the market's reaction to the disclosure of non-GAAP earnings measures that are combined with high impression management. They document that, although non-GAAP measures can be informative to investors, the non-GAAP adjustments are more persistent when they go along with more impression management. ...
Article
This study evaluates EBITDA as a financial performance measure and investigates the use of EBITDA in financial reporting. First, we take issue with recent comments that both the SEC and the IASB have levied against non-GAAP earnings numbers, and in particular EBITDA. While EBITDA allegedly provides an accurate reflection of the operations and abstracts from how assets are financed, we argue that (net) operating profit already provides this information without the necessity of making subjective adjustments. Also, our evidence suggests that EBITDA paints a rosy picture of the firm’s profitability and cash-generating ability. Next, using textual analysis, we investigate the prevalence of EBITDA in financial disclosures based on a large sample of 15,895 annual reports and 51,758 earnings releases from S&P 1500 firms between 2005 and 2016. We find that 14.8% of sample firms disclose and emphasize EBITDA numbers. EBITDA disclosures modestly increase over time and tend to be rather sticky in nature. In our cross-sectional analyses, we find that, consistent with our hypotheses, EBITDA-reporting firms are smaller, more leveraged, more capital-intensive, less profitable and have longer operating cycles than non-EBITDA reporting firms. They also exhibit higher forecast errors and a higher likelihood of missing the analyst forecast benchmark. Additional tests further underscore the opportunistic nature of EBITDA disclosures as we find that these firm characteristics are more strongly associated with the disclosure of adjusted EBITDA measures, and less strongly associated with the disclosure of EBITA and EBIT.
... Entretanto, a ocorrência de divulgação de informações de caráter facultativo incompatível com a realidade pode ser acarretada pelo fato de que os stakeholders recompensam as entidades que possuem um bom desempenho (Isidro & Marques, 2020). Considerado que a divulgação de métricas de desempenho de caráter facultativo, como o EBITDA, é uma prática generalizada (Black et al., 2018), com uma informação relativamente barata de medir e evidenciar, além de ser oportuna (Isidro & Marques, 2020), pode ser utilizada para influenciar a percepção do investidor sobre o desempenho da entidade (Guillamon-Saorin et al., 2017). Adicionalmente, a divulgação pode evidenciar a rentabilidade futura (Wiggins & Ruefli, 2002), a baixa probabilidade de falência (Altman, 1968) e a boa reputação empresarial (Deephouse & Carter, 2005), incentivando os gestores a reportarem um bom desempenho. ...
Conference Paper
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Medidas de desempenho não GAAP, entendidas como aquelas baseadas em dados não contábeis ou em dados contábeis ajustados, como o EBITDA, são difundidos mundialmente junto a investidores e analistas para a análise dos resultados das empresas. Por isso, tais medidas guardam o risco de sofrer com erros e manipulações por parte dos gestores das entidades emitentes. Nesse sentido, objetivo do artigo é identificar as variáveis causadoras das incompatibilidades nos EBITDA divulgados pelas companhias listadas na B3, relacionadas a erros na coleta de dados e a alterações indevidas na fórmula por parte das entidades emitentes da conciliação. Os procedimentos metodológicos consistiram em aplicação de estatística descritiva, com uma amostra de 35 entidades que divulgaram o indicador incompatível referente a 2018, observando a evolução da evidenciação em 2019 e 2020. Os resultados indicam que: o tipo de incompatibilidade mais recorrente foi a subavaliação; os erros de apuração mais comuns se deram na coleta de dados junto às demonstrações contábeis; e a variável que mais impactou nos valores apurados erroneamente foi relativa à depreciação, amortização e exaustão. Conclui-se que, mesmo com a normatização da evidenciação do EBITDA pela Comissão de Valores Mobiliários a partir de 2012, ainda são comuns erros de apuração desse indicador, o que reforça a necessidade de estudos práticos que verifiquem a conformidade dessas divulgações não GAAP das companhias. Palavras-chave: EBITDA; Erros metodológicos; Medida não GAAP. Linha Temática: Contabilidade Financeira / Evidenciação e análise de informações contábeis (GAAP) e não contábeis (Non-GAAP). -------------------------------- KISTNER, S. P.; PLATT NETO, O. A. Análise metodológica dos EBITDA incompatíveis divulgados pelas companhias listadas na B3: identificação das variáveis divergentes nas conciliações. In: CONGRESSO UFSC DE CONTROLADORIA E FINANÇAS, 12. & UFSC INTERNATIONAL ACCOUNTING CONGRESS, 5., 2022, Florianópolis. Anais [...]. Florianópolis: UFSC, 2022. Disponível em: https://congressocontroladoriaefinancas.ufsc.br/. Acesso em: 27 set. 2022. ------------------------------------- https://12congresso.s3-us-west-2.amazonaws.com/app_3_events/ev_59/sub_761/conf_23_own_2978_1658090283940vZJ4NnBWQ37P8cEgr5JDtfoT_aoLcJOZRe65QA6Wu0h4hMNOXjCgN4kf7r3icJLMkWi6Y0MP_g_75yYI4Cbnfb71pS2.vG1eic6SaKUMwI37RI.28SN_jzeP0mA_IfvIRFjWlLkYpZKWgtFzt60lQ3uZd8xg0i3azQzJpJYjq7DIkPG80PL5_u8ZAvqa4Q8W4HFhLysc.pdf
... We believe that the experimental study of managers could contribute to a better understanding of managers' decisions (not) to disclose APMs, although it may be difficult to find a sufficient number of managers as research subjects to include in a sample. Third and finally, as already mentioned by Hitz (2010a), we note that the analysis of publication media using qualitative methods has hardly found any application (e.g., Guillamon-Saorin et al. 2017;Taylor and Keselj 2020). The use of qualitative methods such as content analysis may allow, for example, the identification of semantic patterns in the presentation of APM disclosures and their determinants (similarly Hitz 2010a), "so that investors are aware how different reporting practices of these measures can affect their decisions and market outcomes" (Marques 2017). ...
Article
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For more than two decades, the reporting of so-called ‘alternative performance measures’ (APMs) has been a common phenomenon in external financial reporting. APMs are voluntarily disclosed and generally unaudited performance measures. Typically, APMs modify earnings measures calculated in accordance with generally accepted accounting principles (GAAP) by (subjectively) adjusting certain earnings components. In the academic literature, with the information motive on the one hand and the motive of (adversarial) investor influence on the other hand, two alternative explanations for the voluntary reporting of alternative performance measures are discussed, which are difficult, if not impossible, for external stakeholders to disentangle. Taking into account the recent developments in more than 250 published articles in the last decade, this paper critically reviews a wide range of literature from the United States (U.S.), Europe and, to a less extent, Australia/Asia. In particular, we analyse a comprehensive sample of more than 400 research papers published in academic and professional journals as well as other publications which are important in the academic discourse. The purpose of this paper is to identify relevant research gaps that provide starting points for future research. For this purpose, our methodological approach strictly follows structured literature review (SLR) methodology in order to minimise researcher idiosyncrasies. Thus, our SLR facilitates a decided derivation of research gaps based on a reliable and valid analytical framework which has been deductively derived from previous research. - published full open access - free download opportunity https://rdcu.be/cU598
... Danilov and Sliwka (2017) and Loewenstein et al. (2014) showed that when the company lacks objective information and a clear code of conduct (or high-quality signals) and investors lack investment expertise or experience, investors can use low-quality signals to evaluate the quality of a startup enterprise. Guillamon-Saorin et al. (2017) explicitly indicated that the language or statement that organization leaders use is a key signal to evaluate the quality of a company although the signal is of low quality. Despite the low cost these low-quality signals for fundraisers, other related costs may be incurred, such as reputation damage, legal costs, or customer churn . ...
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As an innovative financing activity, online crowdfunding is characterized by extremely high information asymmetry. To reduce this information asymmetry, crowdfunding companies typically use information presentation, feedback, and other means to convey more information about the fundraising project to investors. Whether the information presentation and feedback affect the investment behavior of nonprofessional ordinary investors is yet to be determined. Moreover, the method by which the information presentation and feedback influence the investment behavior and consequently, the financing performance of crowdfunding companies, has to be identified as well. Currently, research on this subject remains deficient. Therefore, with signal theory and the difference in the cost of information transmission considered, this study classifies the information released by fundraisers on the crowdfunding platform into two categories: low-quality signal and high-quality signal. Projects on the JD.com Crowdfunding website are then used as research samples to explore how the difference in signal quality in the information presentation and feedback of crowdfunding projects influences financing performance from the perspective of investors. The results show that low-quality signals such as video duration, the number of updates, and the number of comments on projects positively affect the success of crowdfunding; meanwhile, crowdfunding experience, which represents high-quality signals, positively moderates the relationship between project video duration, project updates, and crowdfunding success.
... Business firms use different legitimization strategies to shape disclosure communications relating to negative occurrences (Rudkin et al., 2018). Prior studies have shown that firms use impression management techniques to hide bad news (Guillamon-Saorin et al., 2017). Furthermore, the choice order may be affected by the auditor's demographics. ...
Article
Purpose – The new audit regulation for disclosure of key audit matters (KAMs) in financial reporting has been introduced in both developed and developing countries. This study investigates the influence of three distinctive sets of variables, namely industry features, firm characteristics, and auditor attributes, on the extent, pattern and level of disclosure of KAMs by companies listed in Bangladesh, an emerging economy. Design/methodology – The study uses qualitative and quantitative research approaches to investigate the pattern of disclosure of KAMs and their determinants. With a sample of 447 firm-year observations from companies listed on the Dhaka Stock Exchange (DSE) over 2018–2020, the study reveals industry-level, firm-level and auditor-specific characteristics that affect KAMs’ communication in the new audit reporting model. Findings – The findings suggest that significant differences exist between firms in the number and types of KAMs reported and the extent of their disclosure. The study findings also observed variations both within and across different industry sectors. Highly regulated firms disclose a greater number of KAMs, while environmentally sensitive firms are found to provide a greater detail of the issues presented as KAMs. Further, both firm size and age positively impact the number of KAMs disclosed and the extent of the disclosure provided. Big-4 affiliated auditors do not issue a significantly higher number of KAMs but deliver extensive details to their KAMs description, compared to non-Big-4 auditors. In addition, while auditors, in general, tend to issue boilerplate KAMs, Big-4 associates are found to disclose more new KAMs. However, audit fees and auditor rotation do not influence KAMs disclosure. Limitations/implications – This study is based on two years of publicly available data. However, future studies could consider in-depth interviews to explore the motivation behind KAMs’ disclosure in Bangladesh and other developing countries with similar cultural and contextual values. Practical implications – These findings have substantial policy considerations for improving firms' audit quality and, thus, their financial reporting quality, with implications for national and international standard-setters, regulators, and other stakeholders. Originality – This study is one of the earliest endeavours to investigate KAMs in a context of an emerging country, such as Bangladesh, which adopted KAMs’ disclosure in 2018.
... Due to the potential negative results of poor performance, managers are incentivized to frame earnings in the best possible light. The accounting literature thus concludes that good news is shared, and bad news is buried in earnings disclosures (Bowen et al., 2005;Guillamon-Saorin, Isidro, & Marques, 2017). ...
Article
Media coverage of earnings is consequential for firms. As such, firms work hard to ensure their performance beats analyst estimates to avoid negative coverage. However, the relationship between performance and coverage might not be as straightforward as firms assume because media coverage is a socially constructed process that reflects journalists’ social and cognitive biases while producing newsworthy content. With this in mind, we unpack the concept of newsworthiness and develop theory regarding how the media targets, in the earnings context, deviance that is socially significant for stakeholders or attaches a deviance frame to news of social significance. In doing so, we examine how the media’s pursuit of newsworthiness shapes the relationship between critical characteristics of earnings announcements—including the firm’s earnings performance, its press releases surrounding earnings, its prior reputation, and its prior media visibility—and media volume and tone. The results of our empirical tests are broadly consistent with our theorizing. Our theory and findings contribute to research on earnings, media coverage, and social evaluations.
... Black et al. (2017) show that firms report non-GAAP earnings aggressively when the costs of accrual-based and real-activity-based earnings management are high. Guillamon-Saorin et al. (2017) provide evidence that managers use non-GAAP disclosure and earnings management to inflate investors' perception about the firm performance. ...
Article
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This paper investigates whether managerial ability is associated with non-GAAP earnings quality. I find that the quality of non-GAAP earnings is greater for high-ability managers than low-ability managers. I also find that investors consider non-GAAP earnings released by high-ability management to be informative. Additional tests show that the positive association between managerial ability and the quality of non-GAAP earnings is stronger when return volatility or managerial stock ownership is greater. The results are robust to alternative measures of managerial ability and non-GAAP earnings quality and to controlling for endogeneity bias. Overall, this paper provides evidence that managers of high ability use non-GAAP reporting as a signaling tool to reduce information asymmetry.
... Although US-based studies have conclusively established the phenomenon that non-GAAP earnings predict firm value better than GAAP earnings, especially because of non-GAAP disclosure specific regulation in that market, European studies are lagging. Guillamon-Saorin et al. (2017) show that for the top 500 European industrial firms, non-GAAP measures are informative to capital markets. The fact that our sample relates to earnings of poor quality, because of SEOs, impacts the relative value relevance of each earnings metric. ...
Thesis
This PhD dissertation comprises of a detailed theoretical study and two empirical studies on financial analysts’ earnings forecasts when firms manage earnings. The first study explains the gap in the literature – what do analysts forecast when earnings are managed – which the subsequent studies aim to fulfill. The second study finds that analysts generally tend to be informative around seasoned equity offerings (SEO), especially after the adoption of the Market Abuse Directive. The third study confirms that in the long-term informative analyst forecasts are more value relevant than accurate analyst forecasts as well as reported earnings around SEOs. These findings contribute to the literature on analyst forecasts by showing that some analysts may deliberately forego accuracy for informativeness.
... The types of adjustments between GAAP earnings and non-GAAP earnings can also point to opportunistic disclosure. Focussing on European companies, Guillamon-Saorin et al. (2017) found evidence suggesting that management use the impression management techniques discussed above to obscure the fact that adjustments include items of a recurring nature, rather than once-off items. ...
Article
Purpose: This paper investigated the potential opportunistic disclosure of ‘earnings before interest, tax, depreciation and amortisation’ (EBITDA) by analysing the association between the quality of EBITDA reconciliations and factors associated with opportunistic disclosure. Design: Ordinary least squares estimation was used to regress an EBITDA reconciliation score on factors associated with opportunistic disclosure for a sample of stock exchange news service reports of companies listed on the Johannesburg Stock Exchange (JSE) for the financial years 2014 through 2016. Findings: The results suggest that the management of JSE-listed companies signal the credibility of EBITDA as a performance measure by providing higher quality reconciliations, rather than using poor quality EBITDA reconciliations to mask potential opportunistic disclosure. Practical implications: The results suggest that JSE-listed companies use EBITDA disclosure for informational purposes, rather than for opportunistic purposes. Value: This paper contributes to a limited corpus of research on EBITDA as non-GAAP earnings measure. It provides support for the adequacy of the JSE’s disclosure requirements in facilitating high-quality financial reports. The results are timely as the JSE is contemplating whether to issue expanded disclosure requirements intended to limit the potential opportunistic use of non-GAAP earnings disclosure.
... Scholars that focus on the investor reaction find that professional investors are able to recognize the opportunistic behaviour of managers and discount non-GAAP information that is accompanied by high impression management. Moreover, investors in more sophisticated markets penalize non-GAAP measures communicated with high impression management (Guillamon-Saorin et al. 2017). When investigating the format for the presentation of non-GAAP disclosure which investors rely on, a comparison between the full non-GAAP income statement (NGIS) and a summary NGIS-containing only those items that cause the difference between GAAP and non-GAAP measures-reveals that the NGIS summary format increases the weight given to non-GAAP earnings performance for investors' decision-making process (Hogan et al. 2017). ...
Article
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The use of non-GAAP performance measures is a widespread, and certainly not a recent, phenomenon. In fact, companies increasingly believe that non-GAAP financial measures play a critical role in their financial communication strategy, and investors often rely on a wide range of non-GAAP measures to evaluate companies’ performance. However, anecdotal evidence also highlights a misleading use of non-GAAP financial measures, these metrics being disclosed more prominently than comparable GAAP metrics, and inconsistently presented from period to period. The apparent ‘schizophrenic’ nature of non-GAAP measures has often attracted scholars’ attention, while national and international security agencies and standard setters have recently renewed their interest in this topic. Therefore, this paper reviews the nearly two decades of research on non-GAAP reporting to offer insights into what academics have learned so far about non-GAAP reporting practices. In particular, this paper analyses the main objectives of the research, the related setting under investigation, the role of non-GAAP disclosure, and the type of non-GAAP metrics, with the aim of describing the evolution of this field of research over time and providing a structured reference point to carry research forward into specific sub-areas of interest.
... A significant stream of financial disclosure research has considered how managers use IM strategies in disclosures of negative financial results. Yan et al. (2019) note the most researched linguistic features include tone (e.g., Boudt & Thewissen, 2019;Caserio et al., 2019;D'Augusta & DeAngelis, 2019;Guillamon-Saorin et al., 2017;Huang et al. 2014;) and readability (e.g., Ben-Amer and Belgacem, 2018;Li, 2008;Lo et al. 2017). Other studies consider how firms use tone or readability manipulation to mask social responsibility shortcomings (Fabrizio & Kim., 2019;Melloni et al., 2016). ...
Article
Purpose The paper examines the difference in the disclosure readability of SEC investigated firms and the population of firms traded in the USA. This study aims to further refine the obfuscation hypothesis and broader impression management theory. Design/methodology/approach The paper used quantitative cross-sectional analysis of archival data gathered from the SEC Accounting and Auditing Enforcement Release Archive and the SEC EDGAR database. A one-sample t -test was used to compare mean readability levels. Findings The paper provides empirical evidence to support the assertion that disclosures of the firms being investigated for “books-and-records” infractions are more difficult to read than the disclosure of the average publicly-traded firm in the USA. Research limitations/implications First, the study did not make direct matched-pairs comparisons of the readability level. Second, the unique nature of the sample means that the results may not be generalizable. Further research is necessary to expand on this current work. Practical implications The paper includes implications for consideration by accounting standards setters, financial regulators and annual report readers. Originality/value This paper addresses an identified need to study the existence and degree of complexity and obfuscation in financial disclosures.
... Bozzolan et al. (2015) and Martínez-Ferrero et al. (2015) also argue that opportunistic managers are more likely to participate in earnings smoothing. These managers tend therefore to relay on different impression management strategies to hide their opportunistic motives (Guillamon-Saorin et al., 2017). The manipulation of annual report is one of these strategies used by opportunistic managers to deceive shareholders (Brennan and Merkl-Davies, 2018). ...
Article
Purpose This study aims to examine the relationship between the corporate social responsibility (CSR) performance and the readability of annual report. The shareholder theory suggests that CSR firms will provide more transparent disclosures because this reflects a socially and environmentally responsible behavior and a firm’s commitment to high ethical standards. In the same time, the agency theory offers an opposite view. It predicts that opportunistic managers use CSR as an entrenchment strategy and hide their maneuvers through complex textual financial disclosures. Design/methodology/approach Based on a sample of 100 listed firms on the French CACAll-shares index over the period from 2013 to 2016, the authors use a panel regression analysis and run other estimation methods (IV-2SLS) and simultaneous equation model to address the endogeneity issues. They assess the readability of annual reports using the Gunning-Fog Index and the Flesch Index derived from the computational linguistics literature. Findings The results show a significant positive relationship between CSR performance and the readability of annual report. Firms engaging in CSR practices are more likely to provide transparent disclosures with higher readability because this reflects a socially responsible behavior and a firm’s commitment to high ethical standards. This result supports the stakeholder theory and the corporate reputational view. The finding is also robust to alternative readability measurements and to endogeneity bias. Practical implications This study helps all market participants to more comprehensively evaluate the CSR performance disclosed on annual report. It encourages managers to consider CSR as a means to prevent the opacity risk through improved information quality. It also drives French authorities to better regulate the narrative disclosure of CSR firms and change the way companies design their reporting practices. Moreover, it encourages CSR rating agencies to become the dominant definition of CSR evaluation by granting more importance to the quality of disclosed information. Originality/value This study extends previous research on the potential impact of CSR on information quality measured by annual report readability in the French context. Unlike prior studies on the impact of CSR on information quality, that focus exclusively on earnings management and adopt qualitative approaches to assess the SCR score, the authors use simultaneously the Gunning–Fog Index and the Flesch Index to assess the information quality and extract the CSR score from the CSRHub database of companies’ social, environmental and governance performance.
... Bozzolan et al. (2015) and Martínez-Ferrero et al. (2015) also argue that opportunistic managers are more likely to participate in earnings smoothing. These managers tend therefore to relay on different impression management strategies to hide their opportunistic motives (Guillamon-Saorin et al., 2017). The manipulation of annual report is one of these strategies used by opportunistic managers to deceive shareholders (Brennan and Merkl-Davies, 2018). ...
Article
This study examines the relationship between the Corporate Social Responsibility (CSR) performance and the redeability of annual report. The shareholder theory suggests that CSR firms will provide more transparent disclosures because this reflects a socially and environmentally responsible behavior and a firm’s commitment to high ethical standards. In the same time, the agency theory offers an opposite view. It predicts that opportunistic managers use CSR as an entrenchment strategy and hide their maneuvers through complex textual financial disclosures. Based on a sample of 100 listed firms on the French CACAll-shares index over the period from 2013 to 2016, we use a panel regression analysis and run other estimation methods (IV-2SLS) and simultaneous equation model to address the endogeneity issues. We assess the readability of annual reports using the Gunning-Fog Index and the Flesch Index derived from the computational linguistics literature. The results show a significant positive relationship between CSR performance and the readability of annual report. Firms engaging in CSR practices are more likely to provide transparent disclosures with heigher readability because this reflects a socially responsible behavior and a firm’s commitment to high ethical standards. This result supports the stakeholder theory and the corporate reputational view. The finding is also robust to alternative readability measurements and to endogeneity bias. This study helps all market participants to more comprehensively evaluate the CSR performance disclosed on annual report. It encourages managers to consider CSR as a means to prevent the opacity risk through improved information quality. It also drives French authorities to better regulate the narrative disclosure of CSR firms and change the way companies design their reporting practices. Moreover, it encourages CSR rating agencies to become the dominant definition of CSR evaluation, by granting more importance to the quality of disclosed information. This study extends previous research on the potential impact of CSR on information quality measured by annual report readability in the French context. Unlike prior studies on the impact of CSR on information quality, that focus exclusively on earnings management and adopt qualitative approaches to assess the SCR score, we use simultaneously the Gunning-Fog Index and the Flesch Index to assess the information quality and extract the CSR score from the CSRHub database of companies’ social, environmental, and governance performance.
... We are referring to the situations where non-IFRS earnings measures (i) meet or beat analysts' forecasts when IFRS figures are below expectations, (ii) are created via the adjustments of recurring items, or (iii) are given more prominence than IFRS measures. Evidence of such behaviours in Europe has been associated with directors' compensation (Isidro & Marques, 2013), the institutional and economic setting where firms operate (Isidro & Marques, 2015), and the use of impression management in press releases (Guillamon-Saorin, Isidro, & Marques, 2017). This evidence leads us to the discussion of how important it is to create a set of requirements on how non-IFRS information may be disclosed. ...
Article
This paper summarises the contents of a comment letter produced by a working group of 12 academics in response to the International Accounting Standards Board (IASB) Discussion Paper on principles of disclosure. The comment letter was submitted by the Financial Reporting Standards Committee (FRSC) of the European Accounting Association (EAA). The work includes reviews of relevant academic literature of areas related to the various questions posed by the IASB in the Discussion Paper, including the ‘disclosure problem’ and the objective of the project, the suggested principles of effective communication, the roles of the primary financial statements and notes, the location of information and the use of performance measures. The paper also discusses the disclosure of accounting policies, the objectives of centralised disclosure, and the New Zealand Accounting Standards Board staff’s approach to disclosure.
... Typically, managers disclose non-GAAP earnings concurrently with GAAP numbers in the earnings announcement press release, which enhances the visibility and potential usefulness of non-GAAP for performance evaluation. Non-GAAP disclosure can also be used to influence users' impression about firm performance (Guillamon-Saorin et al., 2017). Third, non-GAAP metrics are commonly viewed by stakeholders as indicators of recurring firm performance (Frederickson and Miller 2004;Bhattacharya et al., 2007;Choi et al., 2007;CFA Institute, 2016;Center for Audit Quality, 2018). ...
... Managers' 'undoing' of mandated GAAP to create non-GAAP performance measures brings into question the extent to which such disclosure may be selfserving, rather than incrementally informative. Prior empirical research offers at least some evidence that non-GAAP disclosures are opportunistic, as evidenced by managers using these measures to meet earnings benchmarks (Bhattacharya et al., 2004;Heflin and Hsu 2008;Black and Christensen, 2009;Black et al., 2017) or otherwise influence investor perceptions (Guillamon-Saorin et al., 2017). Similar sentiment has been expressed by accounting standard setters, who not surprisingly have recognized the increasing frequency of non-GAAP earnings disclosures as a challenge (Hoogervorst, 2015;IASB, 2017). ...
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Using a large sample of earnings press releases by Australian firms, we compare multiple attributes of non‐GAAP earnings measures with their closest GAAP equivalent. We find that, on average, non‐GAAP earnings are more persistent, smoother, more value relevant, and have higher predictive power than their closest GAAP equivalent. However, the same set of non‐GAAP earnings disclosures are also less conservative and less timely than their closest GAAP equivalent. The results are consistent with non‐GAAP earnings measures reflecting a reversal of the trade‐off between the valuation and stewardship roles of accounting inherent in accounting standards and the way they are applied. We also find that differences in several of these attributes between GAAP and non‐GAAP earnings are more evident in larger firms, firms with lower market‐to‐book ratios, firms with a higher proportion of independent directors, and firms that report profits rather than losses. Our evidence is consistent with the argument that accounting standards impose significant amounts of conditional conservatism at some cost to the valuation role of accounting information. Non‐GAAP earnings measures can therefore be seen as a response to the challenges faced by a single GAAP performance measure in satisfying the competing demands of value relevance and stewardship.
... Indeed, high analyst coverage was found to curb earnings management practices (Degeorge et al., 2013;Liu, 2014;Yu, 2008) and detect frauds (Chen et al., 2016;Dyck, Morse, & Zingales, 2010). Analysts were found to limit impression management via narratives (Guillamon-Saorin, Isidro, & Marques, 2017;Zhang & Aerts, 2015) as, when they find these practices "implausible" they make negative inferences about the company's prospects (Barton & Mercer, 2005). According to this "monitoring effect" (Yu, 2008), financial analysts could discourage impression management (Chen et al., 2016). ...
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This article investigates whether and how the demand for information at country and firm levels affects the selective use of key performance indicators graphs in corporate annual reports. Our study finds that the country-level and firm-level demands for information provide an incentive, rather than a curb, for a selective display of key performance indicators, which is an important concern in corporate communication and reporting. The external pressure from the demand for information seems to encourage, rather than discourage, impression management. We suggest that annual report readers should use graphical information with caution as companies are likely to provide a self-serving, nonneutral, account of their performance in those contexts where the pressure to perform is higher.
... In contrast, foreign investors have a different strategy for discipline management, that of 'exit' [27,28] because they can significantly affect stock prices through trading [2,29]. Given that sophisticated investors tend to penalize firms when signals cause them to change their belief regarding earnings quality [30][31][32], a firm's earnings quality revealed after amendment might affect foreign investors' beliefs, resulting in sales of their shares. In particular, foreign investors penalize firms more severely for deteriorated earnings quality because they have a limited source of information and are more likely to rely on publicly disclosed information [18]. ...
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This study investigates whether corporate governance mechanisms are associated with earnings quality, especially accurate earnings reporting, and whether investors react differently to inaccurate earnings according to governance strength. Earnings accuracy is one of the key factors affecting a firm’s sustainability in the sense that reported earnings provide information about a firm’s long-term sustainability and further are directly associated with a firm’s cost of capital. In this paper, we employ the independence of the board of directors (BOD) and foreign ownership as governance mechanisms associated with the earnings gap between audited and unaudited earnings. Using 1976 non-financial firm-year observations listed on the Korea Stock Exchange from 2013 to 2016, we find that the gap between unaudited earnings and actual earnings is smaller for firms with independent BODs and foreign ownership, suggesting that earnings accuracy is higher for firms with effective corporate governance. This study also examines how investors react to the earnings gap. Stock returns to the earnings gap are less negative for firms with independent BODs and are more negative as foreign ownership increases, implying that each mechanism of corporate governance has different effects.
... Managers' 'undoing' of mandated GAAP to create non-GAAP performance measures brings into question the extent to which such disclosure may be selfserving, rather than incrementally informative. Prior empirical research offers at least some evidence that non-GAAP disclosures are opportunistic, as evidenced by managers using these measures to meet earnings benchmarks (Bhattacharya et al., 2004;Heflin and Hsu 2008;Black and Christensen, 2009;Black et al., 2017) or otherwise influence investor perceptions (Guillamon-Saorin et al., 2017). Similar sentiment has been expressed by accounting standard setters, who not surprisingly have recognized the increasing frequency of non-GAAP earnings disclosures as a challenge (Hoogervorst, 2015;IASB, 2017). ...
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Numerous studies have examined Narrative Disclosure Tone (NDT) in different channels of financial reporting over the past decade. Our review of 64 studies aims to analyze tone measurements and areas of debate in NDT literature and to suggest avenues for future research. First, we discuss previous studies that compared tone measures based on alternative wordlists and found that tone measures using domain-specific dictionaries are more powerful than those based on general dictionaries. Future research should benefit from the advanced methods considering natural language processing mechanisms and the meanings rather than word frequency for more accuracy. Second, from the theoretical perspective, studies that linked psychological theories to the tone context are limited. Therefore, we call for more evidence from the upper echelons theory that considers the interdependencies between executives. Finally, we critically review different directions of NDT studies and highlight areas for future research. Mainly, we suggest future research to investigate the determinants of NDT in the areas of top managers-specific characteristics, tax avoidance, audit quality, social capital, and regulatory bodies. We call for more research about tone consistency among different channels of disclosures in companies’ communications with stakeholders.
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We investigate whether managers use their discretion in cash flow forecasts to influence the value of their equity‐based compensation. We find that managers are more likely to issue soft‐talk cash flow forecasts when their equity‐based compensation is higher. This association is affected by the news in management earnings forecasts and the propensity of accrual‐based earnings management. Further analyses show that the documented association is less pronounced after the Securities and Exchange Commission issued Regulation G, for firms with chief executive officers who are older or in their later tenure. Our results are robust to addressing potential correlated omitted variables bias.
Thesis
This study investigates the key factors that drive narrative tone in the UK context where managers have more flexibility to frame narratives with stakeholders. While prior studies examined firm-specific characteristics as determinants of Narrative Disclosure Tone (NDT), and the short-term effect on stock markets as consequences of NDT, the current study employs the upper echelons theory and focusses on top managers’ characteristics as key factors that drive NDT. Moreover, it examines not only narrative tone predictive power but also who has this power inside companies to help with predicting future performance. Using computerised textual analysis, the findings suggest that both observed and unobserved CEO characteristics drive positive tone in the UK context and this relationship is moderated by corporate governance attributes. Specifically, older, female and financial expert CEOs display less positive tone. Considering psychological features, the current study shows that narcissistic CEOs are more likely to display positive tone compared with non-narcissistic CEOs, however, this relationship declines in firms that have a higher independent board. Moreover, audit committee and board independence are negatively associated with positive tone. Additionally, the results show more females on board increases the negative relationship between female CEOs and positive tone. Considering tone predictive power, the current study found that corporate narrative tone is associated with future performance. However, answering the question about who has this power, the results show that an executive’s tone has the power to help with predicting a company’s future performance but not governance’s tone. Moreover, the current study shows that Financial Reporting Council guidance increases corporate narrative tone power in general and executive tone in particular in predicting future performance. Finally, the current research shows that negativity does matter in the UK context as it is significantly associated with future performance. These results have significant implications for top management, policy makers, regulators and the external users of financial reporting.
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This paper discusses potential mechanisms for a walk-down pattern in analysts’ earnings forecasts attributable to economic incentives signalling favour from managers. We put forward that impression management tactics exploiting analysts’ subconscious cognitive biases influence judgments and forecasting processes. Hence, we suggest a framework addressing the interplay of analysts’ economic incentives and subconscious cognitive biases yielding forecast walk-downs. This paper is an important step toward enhancing the understanding of how forecasting processes are subject to subconscious cognitive biases and explicit incentives to please managers. Finally, we provide signposts for future research using experimental settings on the interplay of analysts’ incentives and cognitive biases, helping unpack the biases at play
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We express gratitude to Andres Lozano and Lily Polic for their extensive efforts in hand-collecting the data used in this study. We also thank the participants at the 2018 Financial Markets and Corporate Governance Conference, the 2018 European Accounting Conference, and to the seminar participants at the University of Mannheim, for their helpful comments. We have benefited from the constructive feedback provided by the two anonymous reviewers and the associate editor Beatriz García Osma. Special thanks go to Paul Mather and Ted Christensen for their feedback, and to Dirk Black who kindly guided us in the calculation of the consistency and comparability measures. Luisa Unda acknowledges financial support from an Early Career Research Grant from the Monash Business School at Monash University. Sue Wright acknowledges financial support from the UTS Business School at University of Technology Sydney.
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Non-GAAP earnings have received attention recently. Existing literature suggests CEOs’ educational backgrounds affect the financial reporting quality. Thus, the paper analyzes whether the educational background of CEOs affects the disclosure of non-GAAP earnings. Using logit regression to examine the probability of non-GAAP earnings disclosures, this study finds the coefficient value of MBA is 0.4171, which suggests that CEOs with an MBA degree are more likely to disclose non-GAAP earnings than other CEOs. In addition, the moderating effect of audit committee quality on the association between CEO educational backgrounds and non-GAAP earnings disclosures is investigated. The coefficient value of MBA×ACC_QUA is –2.809, which suggests that audit committee quality negatively moderates a positive association between MBA-holding CEOs and non-GAAP earnings disclosures. By focusing on a company’s non-GAAP earnings, this study contributes to the financial reporting literature. The results provide evidence that CEO education backgrounds and audit committee quality influence firms’ non-GAAP earnings disclosures. AcknowledgmentThe author acknowledges the financial support of the National Science and Technology Council, R.O.C. (Award number MOST 111-2410-H-035-048-).
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We investigate the disclosure of non‐IFRS performance measures by 400 companies from eight countries using IFRS Standards (Australia, France, Germany, Hong Kong, Italy, Singapore, Sweden and the United Kingdom) in the years 2005, 2008, 2011 and 2013 (1595 company‐years). The incidence of disclosure is higher in UK and France but lower in Hong Kong, Germany and Singapore. Exclusions relating to impairment, tax, and mergers and acquisitions are frequent. Firms making non‐IFRS disclosures are more likely to be larger, have higher leverage, and exhibit greater volatility in their reported income. Additional tests show national reporting traditions and practices affect non‐IFRS disclosures.
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Disclosure tone is an important qualitative characteristic of managerial disclosures. There is mixed evidence on the role of tone in disclosure strategy. While some studies highlight the informativeness of disclosure tone, other studies provide evidence consistent with an information obfuscation role. We conjecture that the mixed evidence may be because prior studies have not explicitly modeled the role of oversight over managerial disclosure. Using an exogenous shock to institutional ownership, an important source of managerial oversight, we find that abnormal disclosure tone is informative of firm's future earnings and cash flows when institutional ownership is high. This positive association between institutional ownership and informativeness of abnormal tone is stronger when there is an increase in quasi‐indexer institutional ownership and the contemporaneous performance is negative. Collectively, the results highlight a more complex role for disclosure tone. Abnormal disclosure tone could be reflective of managerial sentiment and convey forward‐looking information to investors in the presence of greater oversight over managerial actions. This article is protected by copyright. All rights reserved
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Purpose This study aims to assess if the voluntary reporting of adjusted earnings before interest, taxes, depreciation and amortization (EBITDA), a widely used non-generally accepted accounting principles (GAAP) measure, has effects on information asymmetry and value relevance and how the adjustments to GAAP earnings made to derive it contribute to these effects. This study focuses on firms from two countries with contrasting institutional settings, Canada and France. Design/methodology/approach Relying on multivariate analyses and using Heckman’s procedure to address the sample self-selection issue, this study first estimates the likelihood of a firm to report adjusted EBITDA. Then, this study examines if adjusted EBITDA, as well as the adjustments made to GAAP earnings to derive adjusted EBITDA (adjustments), affect a firm’s information asymmetry and its value. These adjustments are essentially GAAP-grounded items that are discarded by management to derive non-GAAP adjusted EBITDA. The dependent variables are share price volatility, as a proxy for information asymmetry, alongside market-to-book and stock market return as indicators of value. Findings In terms of the used sample, results suggest that Canadian firms are much more likely to report adjusted EBITDA than French firms. Chief executive officer (CEO) attributes (CEO power) appears to increase such likelihood. Moreover, for both Canadian and French firms, adjusted EBITDA is associated with reduced stock market volatility, an indication of lower information asymmetry, as well as higher market-to-book and returns, suggesting value relevance. The results also indicate that investors view the adjustments to GAAP earnings made by management to derive adjusted EBITDA as not value relevant (similar to noise). The GAAP-grounded elements that management discard to derive adjusted EBITDA actually increase information asymmetry. Originality/value This study adds to prior research on the interface between a CEO attributes and governance and non-GAAP reporting. This study also provides evidence that, despite very different institutional settings, non-GAAP reporting conveys relevant information to capital markets’ participants in both France and Canada. Hence, a country’s institutional setting may have a differential impact on the disclosure choice but not on the resulting value relevance of such disclosure. Finally, this study extends the non-GAAP literature by examining the value relevance of a widely used yet under-researched measure, adjusted EBITDA.
Article
The purpose of this paper is to investigate whether the firms with the same Big Four audit firm and from the same legal system disclose more comparable non-GAAP measures. Using 23,436 pairs of European firms, we hand-collected infor-mation on the non-GAAP measures disclosed in the statement of comprehensive income. The results showed that the firms with the same Big Four audit firm or from the same legal system are positively and significantly associated with non-GAAP comparability. Our work adds to the studies on accounting comparability. Furthermore, it provides fresh insights that support the latest IASB activity on the Primary Financial Statement project, under which the standard setter has en-dorsed ED/2019/7 General Presentation and Disclosures.
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Prior research documents that analysts’ non-GAAP, or ‘street earnings’ exclude transitory items in order to facilitate security valuation. We study sell-side analysts’ reports for large European banks and find significant variation in analysts’ non-GAAP actual earnings measures. These measures are not always easily reconcilable to firms’ reported non-GAAP earnings, to GAAP earnings or to non-GAAP earnings reported by I/B/E/S. By contrast, reported measures of GAAP earnings in analysts’ reports differ from one another (or from firms’ reported GAAP earnings) far less often. When evaluated against analysts’ own actual non-GAAP earnings measures, forecasts appear more accurate than those based on I/B/E/S actuals. Results for GAAP earnings are less conclusive. Our results indicate that as well as disagreeing about future earnings, analysts also disagree significantly about what earnings were in the past. This article is protected by copyright. All rights reserved
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Most Form 10-K filings include non-informative innovation-related words. This study shows that textual emphasis on innovation (TEI) reflects the firm’s intention to focus on the long term and finds TEI to be trustworthy. TEI is positively associated with a firm’s long-term investment and negatively associated with a firm’s under-investment. Trustworthiness increases when the firm is subject to increased scrutiny. However, this signal is costly, because it is associated with over-investment in innovation. The study contributes to the impression management and soft disclosure literatures and presents an efficient firm-level measure in fighting short-termism pressure.
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Scholarly findings on whether disclosure of Non-GAAP earnings is informative or opportunistic are inconsistent. Since the 2003 implementation of Regulation G, investors can view management's process of adjusting from GAAP earnings to Non-GAAP earnings. This study investigates the information content of Non-GAAP earnings in the context of restatements. The hypotheses of this study are based on the following two propositions. First, the informativeness of Non-GAAP earnings is determined by the nature of items excluded from GAAP earnings to derive Non-GAAP earnings (either nonrecurring special items or recurring exclusions). Second, restatements can be used to distinguish between informative and opportunistic Non-GAAP earnings disclosures. My results show that firms with restatements, especially fraud or core earnings restatements, exhibit greater relative use of Non-GAAP earnings disclosures that adjust GAAP earnings for positive other exclusions (recurring expenses). By contrast, disclosures of Non-GAAP earnings derived by excluding nonrecurring expenses (special items) from GAAP earnings are not associated with restatements.
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This chapter discusses solutions for building relational ‘organizational intelligence’ and the use of the latter in effecting change. The era of Industry 4.0 (aka Smart World) involves specific priorities concerning what changes are needed and how they should be effected. Organizations used to be viewed as compilations of tasks, products, employees, profit centers and processes. Today, they are increasingly seen as intelligent systems designed to manage knowledge in a relational setting. Multiple techniques and solutions have been proposed for attaining Industry 4.0 priorities, often causing confusion rather than helping to deliver results. This chapter develops a framework for a systematic analysis of organizational intelligence and its application. Due to the multifaceted nature of the issue, the study includes a method for monitoring factors that stimulates organizational intelligence, factors such as new, disruptive technologies. The framework helps improve change processes leading to implementing relational strategies. Keywords: Organizational Intelligence, Industry 4.0, Technology, Relational Strategies, Organizational Change
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Narrative reporting, both in relation to financial and non-financial information, is increasingly used and often mandated, with significant managerial discretion regarding content. As policy makers consider reporting as a tool for regulation to steer the behaviour of companies towards improving practices and performance upon which they have to disclose, the aim of this paper is to provide the state of the art in the academic literature on narrative reporting and identify future challenges. In order to do so, the paper investigates three questions: (1) How has the quality of narrative reporting been defined? (2) What narrative information is required and used by various stakeholders? (3) What are the real effects of narrative reporting? In answering these three questions, our review also gives implications for both future academic research and policy makers.
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We examine the association between CEO cash and equity compensation and non-GAAP disclosure practices in a responsive regulatory and opaque compensation reporting environment. Our empirical evidence, based on a sample of public companies in New Zealand, shows that CEO cash compensation is associated with the likelihood and frequency of non-GAAP disclosures, whereas equity incentives are not. Our results document evidence of an increase in the frequency of non-GAAP disclosures and a decrease in the provision and quality of reconciliation between non-GAAP measures and closely related GAAP measures around CEO cash compensation. In particular, managers use these disclosures when their GAAP earnings benchmarks are missed. A marginal decrease in opportunistic non-GAAP disclosures following the adoption of the International Financial Reporting Standards (IFRS) indicates little change in reporting behavior following adoption of IFRS. Our findings suggest that managers disclose non-GAAP measures with opportunistic intentions motivated by compensation and points to the need for regulators to set policy about clear reconciliation standards.
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Alternative performance measures (APMs) might be used to improve the information environment or strategically to mislead the market. The recently introduced European Securities and Markets Authority APM guidelines are intended to enhance corporate financial disclosures. We analyse the disclosure quality and determinants of all types of APMs in management reports of German listed firms for two financial periods. Although the quantity of APM disclosures is extensive, it differs across firms’ characteristics, and there is considerable room for improvement regarding disclosure quality. APM disclosure quality is positively associated with firm size and negatively associated with profitability. However, not all firms’ characteristics can be applied per se as universal determinants of APM disclosure quality, and a distinction must be made between different types of APMs. For example, high ownership concentration is negatively associated particularly with the quality of profitability APMs. Firms’ leverage is positively associated with the disclosure quality of non-profitability APMs.
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Publicly traded companies in the U.S. must prepare financial statements in accordance with the requirements of U.S. Generally Accepted Accounting Principles (U.S. GAAP). However, many companies also report non-GAAP measures—those calculated outside the requirements of U.S. GAAP—in their earnings announcements, annual reports, and SEC filings. The SEC began regulating the release of non-GAAP measures in 2003 and has expressed ongoing concern regarding firms’ disclosure of the same, but the use of non-GAAP measures continued to increase nonetheless. A 2018 Audit Analytics report found that in 2006, 76% of SEC filers included non-GAAP measures, but in 2017 that percentage rose to 96%. This installment of Accounting Matters provides an overview of the SEC regulations regarding non-GAAP measures, examines how investors react to non-GAAP disclosures, and provides guidance regarding how companies can avoid receiving a non-GAAP disclosure comment letter from the SEC.
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We examine the role of industry-level product market competition on non-GAAP disclosure decisions. We consider traditional measures of industry competition (concentration, price-cost margin, and set up costs), and large reductions in import tariff rates that identify an exogenous increase in competition. We find that competition intensity influences the likelihood of non-GAAP disclosure and the magnitude of non-GAAP exclusions. Our evidence suggests that strong competition encourages managers to disclose higher non-GAAP earnings. However, when competition is strong, firms with low performance relatively to the industry exclude smaller amounts. We also find that in competitive environments, managers are more likely to provide reconciliations and are less likely to exclude recurring items that are commonly excluded by other firms in the industry. These findings indicate that industry competition has a positive influence on the transparency of non-GAAP disclosures.
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SYNOPSIS Efficient capital markets rely on a continuous supply of reliable, timely, and audited information. The economic value of an audit derives from the reduction in risk of erroneous or manipulated information. Traditionally, the auditing has focused on annual financial reports. Given the speed of information creation and dissemination, the role of auditors may need to adapt. There are three areas in which auditors might help improve information quality: (1) non-GAAP earnings; (2) ESG reporting; and (3) cybersecurity risks disclosures. To provide assurance over these types of information, audit firms need to identify the appropriate subject matter for assurance, obtain expertise to provide assurance, develop a verification process, and commit to a system of organizational support. Multidisciplinary practices have the potential to provide many types of expanded assurance. However, success is not inevitable, and market, social, and regulatory forces will have much to say about the emergence of new assurance initiatives.
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This study examines the links between conditional conservatism in financial accounting and certain changes in the institutional frameworks in Australia, France, Japan and the United States of America (US) during the period 1981-2008. We identify specific time periods where changes in market regulation and financing structure; harmonisation and convergence of accounting standards; and corporate governance occurred. We find that conditional conservatism, measured using the Basu (1997) model, decreased in all four countries over the study period. Indeed, by the end of the period studied, there was little support for the existence of conditional conservatism in any of the four countries. However, it is important to note that the pattern and timing of the changes varied across the four countries.
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We use textual analysis to examine whether non-GAAP earnings receive greater emphasis than GAAP earnings in the conference calls that accompany earnings announcements. We measure relative emphasis, i.e. prominence, based on the first appearance or frequency of GAAP and non-GAAP earnings per share (EPS) dollar amounts in the transcripts of conference calls. To complement our analysis of relative emphasis on non-GAAP earnings, we measure general non-GAAP content using frequency counts of keywords. We find that firms place greater relative emphasis on non-GAAP earnings and include more general non-GAAP content when the non-GAAP results exceed the GAAP results, when the non-GAAP results achieve a benchmark that the GAAP results missed, and when the firm’s GAAP earnings are less value-relevant. We find somewhat weak evidence that impression-management motivation is the dominant explanation for greater relative emphasis on non-GAAP earnings but not for general non-GAAP content. Overall, the construct and measurement of relative emphasis on non-GAAP earnings and general non-GAAP content differ, but results indicate they are complements in explaining the market response to earnings conference calls.
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We critically assess mainstream accounting and finance research applying methods from computational linguistics (CL) to study financial discourse. We also review common themes and innovations in the literature and assess the incremental contributions of work applying CL methods over manual content analysis. Key conclusions emerging from our analysis are: (a) accounting and finance research is behind the curve in terms of CL methods generally and word sense disambiguation in particular; (b) implementation issues mean the proposed benefits of CL are often less pronounced than proponents suggest; (c) structural issues limit practical relevance; and (d) CL methods and high quality manual analysis represent complementary approaches to analyzing financial discourse. We describe four CL tools that have yet to gain traction in mainstream AF research but which we believe offer promising ways to enhance the study of meaning in financial discourse. The four tools are named entity recognition (NER), summarization, semantics and corpus linguistics. This article is protected by copyright. All rights reserved
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Prior research reports that analysts focus on street earnings, which are measures that typically exceed GAAP earnings. Using a sample of CEO turnovers from 1993 to 2016 we show that the likelihood and speed of forced CEO turnover - but not voluntary turnover - are higher when analysts exclude income-decreasing items. The association between exclusions and forced turnovers is particularly pronounced for high magnitude exclusions. We also show that greater street exclusion of income-decreasing items, the lower CEO bonus payouts. We find that boards use audited and more conservative GAAP earnings in evaluating and dismissing CEOs, except in the recent period of 2010–2016.
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Purpose The purpose of this paper is to examine the possibility of South African companies listed on the Johannesburg Stock Exchange (JSE) using adjusted earnings as a part of an impression expectation management strategy focused on demonstrating how reported earnings measures meeting or beating analysts’ earnings forecasts. Design/methodology/approach A multiple response analysis approach is used. Earnings adjustments are coded according to a defined typology and assessed for their status as either valid or invalid. The number of occurrences of adjusted earnings measures over a five year period (2010-2014) meeting or beating analyst forecasts is calculated. Findings The use of adjusted earnings by JSE listed companies is a common occurrence. There is evidence to suggest that this is used part of an impression expectation management strategy. Most of the adjustments are invalid. When otherwise valid adjustments are used in a particular year, these are frequently repeated, and when adjusted earnings are reported, these normally exceed analysts’ forecasts. Research limitations/implications The paper is based on a relatively small sample from a single jurisdiction and limited time period. Nevertheless, the findings point to the need to revisit how financial performance is measured and reported, evaluate additional regulation to protect investors and understand in more detail exactly how and why companies use adjusted earnings as an impression expectation management tool. Originality/value The paper adds to the limited body of research on performance reporting outside of the USA and Europe. It also examines the use of adjusted earnings in a unique setting where, in addition to IFRS numbers, companies are required to report a mandatory adjusted earnings figure (headline earnings).
Article
Purpose This study aims to explore the firm’s and country-level institutional forces that determine banks’ CSR reporting diversity, during the recent global financial crisis. Design/methodology/approach Specifically, this study assesses whether economic and institutional conditions explain CSR disclosure strategies used by 30 listed and unlisted banks from six countries in the context of the recent 2007/2008 global financial crisis. The annual reports and social responsibility reports of the largest banks in Canada, the UK, France, Italy, Spain and Portugal were content analyzed. Findings The findings suggest that economic factors do not influence CSR disclosure. Institutional factors associated with the legal environment, industry self-regulation and the organization’s commitments in maintaining a dialogue with relevant stakeholders are crucial elements in explaining CSR reporting. Consistent with the Dillard et al.’ s (2004) model, CSR disclosure by banks not only stems from institutional legitimacy processes, but also from strategic ones. Practical implications The findings highlight the importance of CSR regulation to properly monitor manager’s’ opportunistic use of CSR information and regulate the assurance activities (regarding standards, their profession or even the scope of assurance) to guarantee the proper credibility reliability of CSR information. Originality/value The study makes two major contributions. First, it extends and modifies the model used by Chih et al. (2010). Second, drawn on the new institutional sociology, this study develops a theoretical framework that combines the multilevel model of the dynamic process of institutionalization, transposition and deinstitutionalization of organizational practices developed by Dillard et al. (2004) with Campbell’s (2007) theoretical framework of socially responsible behavior. This theoretical framework incorporates a more inclusive social context, aligned with a more comprehensive sociology-based institutional theory (Dillard et al. , 2004; Campbell, 2007), which has never been used in the CSR reporting literature hitherto.
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This paper introduces a measure of firm-specific cybersecurity awareness that can be used in empirical research exploring cyber-related issues facing corporations. It extends and updates Gordon et al. (2010), who develop an indicator capturing the existence of disclosures related to “information security” and show a positive association between market valuation and their measure. Since publication of their paper, cyber-related events have become more frequent and salient, and disclosure of cybersecurity issues has become more extensive. Increased disclosure is largely due to a 2011 requirement by the Securities and Exchange Commission, which provides guidance for disclosure of cyber-related issues in 10-K filings. Based upon this post-guidance disclosure, we develop a new measure that captures the extent and relevance of cyber disclosures and show that the market positively values cybersecurity awareness. We also show that a more negative tone in cyber disclosures is associated with lower market values. Our results are robust to inclusion of measures of IT governance and controlling for the firm's overall disclosure characteristics.
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Limited attention theory predicts that higher salience of earnings news implies a stronger immediate market reaction to earnings news and a weaker post-earnings announcement drift (PEAD) or reversal (PEAR). Using a new measure, SALIENCE, defined as the number of quantitative items in an earnings press release headline, we find strong evidence consistent with salience effects. Higher SALIENCE is associated with stronger announcement reaction and subsequent PEAR. Managers are more likely to choose higher SALIENCE before selling shares in the post-announcement period and when earnings are high but less persistent, and to choose lower SALIENCE before stock option grants. The results are robust to using residual salience and an extended set of control variables. The findings are consistent with managers opportunistically headlining positive financial information in the earnings press release to incite overoptimism in investors with limited attention.
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We use a new data set to study the determinants of the performance of open-end actively managed equity mutual funds in 27 countries. We find that mutual funds underperform the market overall. The results show important differences in the determinants of fund performance in the USA and elsewhere in the world. The US evidence of diminishing returns to scale is not a universal truth as the performance of funds located outside the USA and funds that invest overseas is not negatively affected by scale. Our findings suggest that the adverse scale effects in the USA are related to liquidity constraints faced by funds that, by virtue of their style, have to invest in small and domestic stocks. Country characteristics also explain fund performance. Funds located in countries with liquid stock markets and strong legal institutions display better performance.
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This study presents the results of an experiment that examines how two underlying characteristics of pro forma earnings announcements, pro forma emphasis and the presence of a quantitative reconciliation, influence non-professional investors' and analysts' reliance on pro forma disclosures. The results indicate that the emphasis management places on pro forma earnings, not the mere presence of pro forma earnings, influences non-professional investors' judgments and decisions, but that this influence is mitigated by the presence of a quantitative reconciliation. Further analysis reveals that the influence of pro forma emphasis on nonprofessional investors' judgments and decisions seems to be the result of an unintentional cognitive effect as opposed to the perceived informativeness of the earnings figure emphasized by management. Analysts' judgments and decisions were also affected by the presence of reconciliation, but in the opposite direction to those of nonprofessional investors. Specifically, the presence of a quantitative reconciliation led analysts to view pro forma earnings as more reliable, increasing their reliance on the pro forma disclosure in judging the earnings performance of the firm.
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In recent years, many companies have emphasized adjusted-GAAP earnings numbers in their quarterly press releases. While managers use different names to describe these non-standard 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, 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.
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We use textual-analysis software to quantify the language used in earnings press releases and the corresponding Management Discussion and Analysis (MD&A) for approximately 13,000 firm quarters between 1998 and 2003. Analyzing two narrative disclosures in which managers describe firm performance for the same quarter allows us to examine managers’ use of language across alternative communication outlets. Our general prediction, which relies on prior literature suggesting that there is a greater market response to information disclosed in an earnings announcement press release versus an SEC filing, is that managers disclose less pessimistic language and more optimistic language in earnings press releases relative to the corresponding MD&A disclosures. We first document that firms exhibit significantly lower levels of pessimistic language and higher levels of optimistic language in earnings press releases relative to the MD&A. We then construct a measure of the proportion of total pessimistic language reported in an earnings press release relative to the corresponding MD&A and find this proportional measure is negatively associated with the intensity of managers’ strategic reporting incentives. In additional analyses, we find a negative association between the level of pessimistic language in the MD&A and future firm performance, controlling for pessimistic language in the corresponding earnings press release. This evidence supports our assertion that managers disclose pessimistic language in the MD&A that provides information incremental to that in the corresponding earnings press release. Overall, our results are consistent with managers’ use of alternative communication outlets as part of a strategy to influence the market’s response to information disclosed.
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We examine the relation between firm-level transparency, stock market liquidity, and valuation across a variety of international settings. We document lower transaction costs and greater liquidity (as measured by lower bid-ask spreads and fewer zero-return days) for firms with greater transparency (as measured by less evidence of earnings management, better accounting standards, higher quality auditors, more analyst following and more accurate analyst forecasts). The relation between transparency and liquidity is more pronounced in periods of high volatility, when investor protection, disclosure requirements, and media penetration are poor, and when ownership is more concentrated, suggesting that firm-level transparency matters more when overall investor uncertainty is greater. Increased liquidity is associated with lower implied cost of capital and with higher valuation as measured by Tobin’s Q. Finally, a mediation analysis suggests that liquidity is a significant channel through which transparency affects firm valuation and equity cost of capital.
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Prior research finds that firms warning investors of an earnings shortfall experience lower returns than non-warning firms with similar risks and earnings news. Openness thus appears to be penalized by investors. Yet, this finding may be due to a self-selection bias that occurs when firms with a larger amount of unfavorable non-earnings news (other bad news) are more likely to warn. In this paper I use a Heckman selection model to infer the amount of other bad news and document that, on average, warning firms have a larger amount of other bad news than non-warning firms. After controlling for this effect, I find that warning firms' returns remain lower than those of non-warning firms in a short-term window ending five days after earnings announcement. When this window is extended by three months, however, warning and non-warning firms exhibit similar returns. My evidence suggests that openness is ultimately not penalized by investors.
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We explore whether investors’ perceptions of pro forma earnings numbers have changed following the regulation of pro forma reporting imposed by the Sarbanes-Oxley Act of 2002 (SOX). First, we find that investors appear to pay more attention to pro forma earnings disclosures in the post-SOX period, consistent with the notion that they perceive that regulation generally renders these disclosures more credible. Second, the results indicate that investors discount aggressive pro forma earnings reports in both periods. However, they appear to discount at least some potentially misleading pro forma earnings disclosures more in the post-SOX period. Finally, our results imply that the regulation of pro forma reporting has increased the average quality of pro forma earnings disclosures by filtering out those that are most likely to be misleading. These results are consistent with the conclusions that (1) the quality of pro forma reporting has improved following SOX, and (2) investors’ perceptions of pro forma earnings metrics have changed in the post-SOX regulatory environment.
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This study examines the tradeoffs that an entrepreneur makes in an initial public stock offering between the incremental costs and benefits of selecting a Big 6 audit firm. The benefit of hiring a Big 6 auditor is assumed to be reduced underpricing, consistent with Beatty (1989) and Balvers, et al. (1988). The cost of hiring a Big 6 auditor is higher auditor compensation. Evidence drawn from a sample of IPOs during the early 1990s is consistent with a differentiated market for audit services where owners select the type of auditor that minimizes the sum of underpricing and auditor compensation costs.
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We contribute to the debate regarding the informativeness of pro forma earnings disclosures by providing evidence that a group of informed traders, short sellers, trade as if firms’ voluntary non-GAAP earnings disclosures create information advantages they can exploit. While prior research indicates that short sellers identify firms that will experience declining operating performance, we investigate whether the disclosure of pro forma earnings acts as an indicator of future price declines that is distinct from poor operating performance. We find that short selling is significantly higher in quarters in which firms disclose non-GAAP earnings metrics relative to quarters in which they do not disclose adjusted earnings measures. Moreover, we find that short selling is significantly positively associated with the exclusion of recurring items and, more particularly, with the exclusion of stock-based compensation. We also find some evidence that short sellers trade more when managers exclude expense items to appear to meet analysts’ expectations on a pro forma basis when they fall short of expectations based on GAAP operating earnings. Finally, we find evidence based on abnormal returns suggesting that short sellers profit from short selling around earnings announcements containing pro forma earnings disclosures. Overall, the results are consistent with the notion that sophisticated market participants view pro forma earnings disclosures negatively and trade in order to take advantage of potential information asymmetries created by these disclosures.
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This paper examines whether, and under what conditions, the linguistic tone (“soft information”) of management’s quarterly earnings press releases predicts firm’s valuation fundamentals and affects stock prices and stock price volatility. We use textual-analysis programs to extract two dimensions of managerial soft information - net optimism and certainty - from more than 20,000 corporate earnings announcements from the period 1998 to 2006. We show that soft information predicts valuation fundamentals (the levels of, and uncertainty associated with, future earnings of the firm), and that it affects asset prices both within the announcement event window and during the 60-trading day post-announcement period. Consistent with a standard Bayesian learning model, two key aspects of the information environment influence the linguistic tone’s impact on share prices: (i) the noisiness of the prior and contemporaneously available hard information; and (ii) the likely credibility of the net optimism itself. We also find that linguistic certainty attenuates the post-announcement period’s response to unexpected net optimism, is associated with contemporaneous announcement period idiosyncratic volatility, and predicts future idiosyncratic volatility after controlling for the simultaneously issued “hard” earnings information and other variables.