The Use of Adjusted Earnings in Performance Evaluation

ArticleinSSRN Electronic Journal · January 2015with 32 Reads
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We examine the use of adjusted earnings in CEO performance evaluation. We find that the majority of firms in the S&P 500 use adjusted earnings for performance evaluation, and that common exclusions such as interest, taxes, discontinued operations, and special items do not fully explain how firms calculate adjusted earnings. This suggests a widespread adoption of firm-specific adjustments to earnings for performance evaluation. Results of cross-sectional tests investigating the use of unadjusted earnings for performance evaluation are more consistent with the use of adjusted earnings improving incentive alignment between shareholders and managers than with managerial power over compensation.

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    The number of firms reporting earnings on a non-GAAP basis has increased dramatically over the last decade, and non-GAAP reporting is now commonplace in capital markets. This proliferation of non-GAAP reporting has renewed both regulators’ and standard setters’ interests in these alternative performance metrics. For example, the SEC, FASB, and IASB have all recently questioned what this increasing reporting trend means for IFRS- and US-GAAP-based reporting and whether these measures are misleading to investors. This increasing focus on non-GAAP metrics motivates us to synthesize the nearly two decades of research on non-GAAP reporting to provide insights on what academics have learned to date about this reporting practice. Then, we utilize a novel dataset of detailed non-GAAP disclosures to provide new descriptive evidence on current trends in non-GAAP reporting and its recent proliferation. Finally, we discuss important questions for future researchers to consider in moving the literature forward.
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