Accounting 300 words. 3hrs

Available online at www.sciencedirect.com

ScienceDirect The International Journal of Accounting 48 (2013) 324–326

Reply

Response to Discussion of: The Effects of Compensation and Board Quality on Non-GAAP

Disclosures in Europe

Helena Isidroa, Ana Marquesb,⁎

a Instituto Universitário de Lisboa (ISCTE IUL), BRU UNIDE, Lisboa Portugal b Nova School of Business and Economics, INOVA, Universidade Nova de Lisboa, Portugal

1. Introduction

We are grateful to the discussant, Peter Fiechter, for the insightful remarks about our paper. The discussant's comments focus on three issues: (1) the link between share-based compensation and opportunistic non-GAAP reporting; (2) the role of varying institutional environments; and (3) the distinction between opportunistic and informative non-GAAP reporting. In this response, we provide clarifications to address these concerns and suggest avenues for future research.

2. The link between share-based compensation and opportunistic non-GAAP reporting

The discussant suggests a more in-depth analysis of the relationship between compensation and opportunistic non-GAAP voluntary disclosure. The first proposed analysis involves the separation between the short-term and long-term compensation incentives. We agree that such an analysis would bring valuable insights to the literature, especially in light of Black, Black, Christensen, and Waegelein's (2011) findings for the U.S. However, as the discussant also recognizes, the data from ISS for Europe does not make such a distinction and it would be necessary to manually collect that information. The second proposed analysis would explore how non-GAAP disclosure practices are affected differently by CEOs' compensation

⁎ Corresponding author at: Nova School of Business and Economics, Campus de Campolide, 1099-032 Lisboa, Portugal. Tel.: +351 918080250; fax: +351 21387933.

E-mail address: [email protected] (A. Marques).

0020-7063/$ - see front matter © 2013 University of Illinois. All rights reserved. http://dx.doi.org/10.1016/j.intacc.2013.07.005

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incentives and by directors' compensation incentives. We believe that our study contributes more to the voluntary disclosure literature by investigating the effect of directors' compensation, where there is little current research. An application of the Black et al. (2011) study on executive compensation in Europe would require additional data. Given that we already hand-collected all of the non-GAAP information, we are willing to share our proprietary data with researchers interested in exploring these issues.

3. The role of varying institutional environments

We agree with the discussant's arguments that substantial variation in the institutional conditions of the countries where the firms operate may affect non-GAAP voluntary disclosure choices. The impact of macro-level conditions on reporting outcomes has been widely documented in the international literature (Ball, Kothari, & Robin, 2000; Ball, Robin, & Wu, 2003; Burgstahler, Hail, & Leuz, 2006; Leuz, 2010; Leuz, Nanda, & Wysocki, 2003). We also believe that the influence of institutional conditions in non-GAAP reporting is likely to be particularly strong in the European setting, given the lack of stringent non-GAAP regulation in Europe (a distinctive feature of the European context relative to the U.S.). This is an important issue that deserves a separate and thorough investigation. As such, the authors explore the influence of institutional conditions on non-GAAP reporting in another study (Isidro & Marques, 2012). That study finds that managers are more likely to use non-GAAP reporting in an opportunistic way (to meet earnings benchmarks) in countries with efficient institutional and economic conditions, which suggests that opportunistic non-GAAP reporting increases in institutionally developed environments where there is more pressure to achieve earnings targets and less opportunity to manipulate reported earnings.

Related to the above point, a research question not yet addressed is how country-level institutional forces and firm-level governance mechanisms (the two factors indicated by the discussant) jointly influence managers' non-GAAP reporting strategies, and whether there is an interaction effect between the two. This is a possible avenue for future research.

With regard to the variation in countries' corporate governance levels, we argue that ISS governance scores are constructed on an internationally comparable basis. However, we agree with the discussant's point that the general corporate governance level of the country is embedded in the firms' specific governance scores. A possible way to isolate the firm specific governance quality is to use a scaled governance score in which the scale is the country governance index reported in Table 1 in the discussion.

4. The distinction between opportunistic and informative non-GAAP reporting

The separation between opportunistic and informative non-GAAP reporting is a critical issue affecting all of the non-GAAP literature, as we cannot directly observe managers' intentions. In our paper, we have studied the reporting practices previously identified in the literature as opportunistic disclosures (e.g., Black & Christensen, 2009; Bowen, Davis, & Matsumoto, 2005; Doyle, Lundholm, & Soliman, 2003; Elliott, 2006; Marques, 2010; Zhang & Zheng, 2011). We have constructed the indicator variables opportunistic disclosure and informative disclosure as a combination of those practices following the

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suggestion of one of the reviewers. Although we find that both the estimated coefficients for compensation are positive and statistically significant (Panel B, Table 6), it is important to consider that the effect is statistically higher in the case of opportunistic disclosure. Thus, while firms that disclose non-GAAP earnings measures with informative intentions do this more frequently when directors' compensation is linked to firms' market performance, they still do it less frequently than firms with opportunistic motivations. Nevertheless, we agree that with a larger panel of observations, one could explore specific combinations of reporting strategies including whether or not the non-GAAP numbers meet analysts' expectations about year earnings. Another possible area for future research is to identify firms that consistently use aggressive non-GAAP strategies through time.

Acknowledgments

We thank Peter Fiechter for the helpful comments and discussion. We acknowledge the constructive comments from the 2011 International Journal of Accounting Symposium, the 2011 IAS mid-year meeting, the 2011 EAA annual congress, and the 2011 AAA annual meeting participants. We also thank the anonymous reviewers and the editor of the International Journal of Accounting, Professor A. Rashad Abdel-Khalik, for their helpful suggestions.

References

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Ball, R., Robin, A., & Wu, J. (2003). Incentives versus standards: Properties of accounting income in four East Asian countries. Journal of Accounting and Economics, 36, 235–270.

Black, D., Black, E., Christensen, T., & Waegelein, J. (2011). The effects of executive compensation contracts and auditor effort on firms' pro forma reporting decisions. Working paper. Duke University.

Black, D., & Christensen, T. (2009). US managers' use of ‘pro forma’ adjustments to meet strategic earnings targets. Journal of Business Finance & Accounting, 36(3), 297–326.

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Isidro, H., & Marques, A. (2012). The role of institutional and economic forces in the strategic use of non-GAAP disclosures to beat earnings benchmarks. Working paper (available at http://papers.ssrn.com/sol3/papers.cfm? abstract_id=1940514).

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Leuz, C., Nanda, D., & Wysocki, P. (2003). Earnings management and investor protection: An international comparison. Journal of Financial Economics, 69, 505–527.

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