Case study: Determinants and economic consequences of non-GAAP financial reporting in Europe
Summary
The financial information disclosed by a firm is critical in supporting investment decisions, as it provides information that is useful to estimate future expected performance. GAAP (Generally Accepted Accounting Principles) earnings are included in the European firms’ financial statements and are subject to auditing and other controls. Non-GAAP earnings refer to alternative measures of financial performance, created entirely voluntarily by managers, disclosed in annual announcements, and are not audited nor regulated in Europe.
The research shows that managers of European firms disclose non-GAAP measures to positively influence investors’ perceptions about the firm performance and to meet earnings targets such as analysts’ forecasts of earnings. The study also shows that managers’ behaviour regarding disclosure of non-GAAP measures varies across countries. The results of the study inform investors, analysts, regulators and the general public that managers may use voluntary disclosure to strategically inflate the firm performance. Investors and regulators should be aware that strategic use of non-GAAP reporting increases in countries where laws and regulations are less protective of investors’ rights and there are less sophisticated investors. The results were particularly important for the European Securities and Markets Authority (ESMA) who is currently issuing guidelines to discipline managers’ non-GAAP disclosure. Academic evidence about non-GAAP reporting is considered by the ESMA when issuing these guidelines. In light of these research results ESMA can consider whether to adopt or not more stringent guidelines, and whether the guidelines should vary across countries.
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