Non-GAAP Measures: Governance

Non-GAAP Measures: Governance

Group 5

Tanya Tappin, Marene Gallimore, Radhika Aggarwal, Kamaljit Sekhon, Tabarak Younis

Sheridan College

ACCG42004D Accounting Theory and Contemporary Issues

Preet Bhalla

April 6, 2023

Introduction

The purpose of this report is to provide insightful information about the role that governance plays in non-GAAP reporting. One of the main advantages of non-GAAP reporting is its ability to provide relevant information to stakeholders however the major disadvantage to this is the fact that reliability is traded off for relevance. Though stakeholders get relevant information this information may not be reliable or verifiable which may motivate managers to report opportunistic non-GAAP measures. A few of these non-GAAP measures include non-GAAP earning figures (EBIT) and adjustment of recurring items.

Summary of Articles

Non-GAAP performance measures virtue or vice?

In this article, the argument is made that non-GAAP performance measures support the overall financial position of a company and demonstrates key factors in decision-making for management, shareholders and potential investors. There is a risk factor involved when using non-GAAP metrics as there needs to be full disclosure for the understandability of users. In this review, connections will be made to Information Symmetry, Quality of Reporting along with Earnings Management and Forecast. 

The joint effects of corporate governance and regulation on the disclosure of manager-adjusted non-GAAP earnings in the US

This article investigates the impact of corporate governance and regulation on the disclosure of manager-adjusted non-GAAP earnings by US firms. It also highlights the importance of governance mechanisms in promoting transparency and accountability in financial reporting and emphasizes the need for regulatory oversight to ensure that companies comply with reporting standards.

The effects of compensation and board quality on non-GAAP disclosures in Europe

This article evaluates the connection between share-based compensation of directors and opportunistic non-GAAP reporting, the role that the institutional environment plays in identifying opportunistic non-GAAP measures, and the final point provides comments made by the author on the issue surrounding whether non-GAAP reporting is opportunistic or informative (Fiechter, 2013). To determine if a positive association exists between the share-based compensation of directors and the reporting of non-GAAP measures the author uses the Hypothetical-deductive investigation method (scientific method) to test his hypothesis which predicts a positive association between the two. Data for this research was obtained from the Institutional Shareholder Services (ISS) and other secondary sources. As it relates to the role that the institutional environment plays in identifying opportunistic non-GAAP measures the author conducts secondary research to reach a conclusion about this topic. Data for this research was obtained from several different research papers including research conducted by ISS and Daniel Kaufmann, Aart Kraay, and Massimo Mastruzzi. The third section of the paper focuses on whether or not non-GAAP reporting is opportunistic or informative. To analyze this matter the author conducts secondary research using data from a research paper done by Helena Isidro and Ana Marques.

The author concluded with the notion that there is a positive association between the share-based compensation of directors and opportunistic non-GAAP reporting. This suggests that when directors are awarded share-based compensation there is a higher chance that management will engage in opportunistic non-GAAP reporting. The author also noted that with good board quality, the use of opportunistic non-GAAP measures is reduced especially as it relates to the weight placed on non-GAAP figures and the overall disclosure. This indicates that corporate governance plays a significant role in management's decisions to report non-GAAP figures. Good corporate governance helps to deter management decisions to engage in opportunistic non-GAAP reporting.

Response to discussion of: The effects of compensation and board quality on non-GAAP disclosures in Europe

In this article, the author addresses the concerns surrounding the connections between share-based compensation and opportunistic non-GAAP measures, the different roles of the institutional environment and the difference between opportunistic and informative non-GAAP reporting. In addition to this next steps for future research were provided. 

Credibility attributes and investor perceptions of non-GAAP earnings exclusions 

The journal article evaluates the difference between stronger credibility attributes and the weaker attributes of the firms. The authors believe that the firms that have stronger credibility attributes provide more credible non-GAAP exclusions than the firms that have weaker credibility attributes.  The article also shows how investors focus more on non-GAAP than traditional GAAP to maximize their profit because non-GAAP earnings are unaudited and disclosed by the firms.

Connection to Course Topic

Non-GAAP performance measures virtue or vice?

The joint effects of corporate governance and regulation on the disclosure of manager-adjusted non-GAAP earnings in the US

The effects of compensation and board quality on non-GAAP disclosures in Europe

This article ties in with governance and the power theory in chapter 10.7 of the textbook, it provides further clarification about share-based compensation and management opportunistic behavior. The power theory assumes that “managers have sufficient power to influence their own compensation, and that they use this power to generate excessive pay, at the expense of shareholder value” (Bebchuk et al., 2002, as cited in Scott & O’Brien, 2020). When managers report favorable non-GAAP figures this can influence market participants to purchase shares which in turn can increase the share price thereby increasing managers' compensation. The article also looks at the impact that governance has on managers’ ability to engage in opportunistic behavior. Both the textbook and the article suggest that the quality of corporate governance plays an important role in controlling managers’ opportunistic behavior. Good corporate governance is said to discourage managers’ opportunistic behavior. Though non-GAAP reporting can provide relevant information to users it can also be misleading if reliability is drastically reduced and if managers are reporting non-GAAP figures for their benefit.

Response to discussion of: The effects of compensation and board quality on non-GAAP disclosures in Europe

Credibility attributes and investor perceptions of non-GAAP earnings exclusions 

Conclusion

References

Fiechter, P. (2013). The Effects of Compensation and Board Quality on Non-GAAP Disclosures in Europe. The International Journal of Accounting 48 (3), 319-323. https://doi.org/10.1016/j.intacc.2013.07.004

Scott, W. R, & O’Brien, P. C. (2020). Financial accounting theory: The Power Theory of Executive Compensation (Eds). Pearson.