UC Berkeley

It is now common for firms to emphasize non-GAAP earnings metrics that exclude certain GAAP-based expenses, such as acquisition and restructuring expenses, intangible asset amortization, asset write-downs, and stock compensation expense. This study hypothesizes that managers become focused on non-GAAP earnings, causing them to underweight excluded expenses when making investment and accounting decisions. Consistent with the underweighting of acquisition-related expenses, firms with a history of reporting non-GAAP earnings over-invest relative to their peers, and engage in more acquisitions. With respect to accounting choices, excluded expenses such as write-downs and stock option expense are recorded and measured more conservatively when excluded from non-GAAP earnings. Using SFAS 141(R) and SFAS 123(R) as difference-in-differences settings, firms’ choices are found to be less sensitive to accounting standard changes when the affected expense is excluded from non-GAAP earnings. The evidence suggests that the use of non-GAAP earnings can influence real activities and accounting choices.