How are Street Earnings Determined? Managers' Influence on Analysts' Exclusions and Agreement

Black, Ervin L.; Christensen, Theodore E.; Kiosse, Paraskevi Vicky; Steffen, Thomas D.

doi:10.2139/ssrn.2992618

Cited by 7 publications

(7 citation statements)

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“…As managers have a better understanding and an insider view of their businesses, analysts and market participants are likely influenced by managers’ non-GAAP exclusions. 8 Consistent with this notion, prior research finds evidence that managers are able to influence analysts’ earnings estimates during the accounting period (Cotter, Tuna, & Wysocki, 2006; Matsumoto, 2002; Richardson, Teoh, & Wysocki, 2004) and also their street earnings reported in I/B/E/S at the end of the period (Christensen, Merkley, Tucker, & Venkataraman 2011; Black, Christensen, Kiosse, & Steffen, 2014). Therefore, based on prior evidence that managers influence analysts’ behavior, we argue that it is important to examine managers’ non-GAAP reporting choices.…”

Section: Regulatory Changes Prior Research and Hypothesis Developmentmentioning

confidence: 89%

Has the Regulation of Non-GAAP Disclosures Influenced Managers’ Use of Aggressive Earnings Exclusions?

Black

Christensen

Kiosse

et al. 2016

Journal of Accounting, Auditing & Finance

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The frequency of non-GAAP (or "pro forma") reporting has continued to increase in the United States over the last decade, despite preliminary evidence that regulatory intervention led to a decline in non-GAAP disclosures. In particular, the Sarbanes-Oxley Act of 2002 (SOX) and Regulation G (2003) impose strict requirements related to the reporting of non-GAAP numbers.More recently, the Securities and Exchange Commission (SEC) has renewed its emphasis on non-GAAP reporting and declared it a "fraud risk factor." Given the SEC's renewed emphasis on non-GAAP disclosures, we explore the extent to which regulation has curbed potentially misleading disclosures by investigating two measures of aggressive non-GAAP reporting. Consistent with the intent of Congress and the SEC, we find some evidence that managers report adjusted earnings metrics more cautiously in the post-SOX regulatory environment. Specifically, the results suggest that firms reporting non-GAAP earnings in the post-SOX period are less likely to (a) exclude recurring items incremental to those excluded by analysts and (b) use non-GAAP exclusions to meet strategic earnings targets on a non-GAAP basis that they miss based on Institutional Brokers' Estimate System (I/B/E/S) actual earnings. However, we also find that some firms exclude specific recurring items aggressively. Overall, the results suggest that while regulation has generally reduced aggressive non-GAAP reporting, some firms continue to disclose non-GAAP earnings numbers that could be misleading in the post-SOX regulatory environment.

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Section: Regulatory Changes Prior Research and Hypothesis Developmentmentioning

confidence: 89%

Has the Regulation of Non-GAAP Disclosures Influenced Managers’ Use of Aggressive Earnings Exclusions?

Black

Christensen

Kiosse

et al. 2016

Journal of Accounting, Auditing & Finance

Self Cite

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“…Black et al. [] find evidence suggesting that the discussion of non‐GAAP performance metrics during the conference call can also influence the actual earnings metric provided by I/B/E/S. This evidence indicates that I/B/E/S non‐GAAP earnings might simply represent an indirect measure of managers’ non‐GAAP numbers…”

Section: Background and Hypothesesmentioning

confidence: 99%

Disentangling Managers’ and Analysts’ Non‐GAAP Reporting

Bentley

Christensen

Gee

et al. 2018

J of Accounting Research

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234

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Researchers frequently proxy for managers’ non‐GAAP disclosures using performance metrics available through analyst forecast data providers (FDPs), such as I/B/E/S. The extent to which FDP‐provided earnings are a valid proxy for managers’ non‐GAAP reporting, however, has been debated extensively. We explore this important question by creating the first large‐sample data set of managers’ non‐GAAP earnings disclosures, which we directly compare to I/B/E/S data. Although we find a substantial overlap between the two data sets, we also find that they differ in systematic ways because I/B/E/S (1) excludes managers’ lower quality non‐GAAP numbers and (2) sometimes provides higher quality non‐GAAP measures that managers do not explicitly disclose. Our results indicate that using I/B/E/S to identify managers’ non‐GAAP disclosures significantly underestimates the aggressiveness of their reporting choices. We encourage researchers interested in managers’ non‐GAAP reporting to use our newly available data set of manager‐disclosed non‐GAAP metrics because it more accurately captures managers’ reporting choices.

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“…3 For example, financial analysts typically exclude components of earnings that they believe are nonrecurring and distort the predictive ability of earnings for future performance (Brown et al 2015). Common exclusions include restructuring, tax resolutions, and acquisitions (Black et al 2019). Both managers and analysts provide non‐GAAP metrics (Bentley et al 2018).…”

Section: Background and Research Questionsmentioning

confidence: 99%

“…When managers provide pro forma earnings, analysts have the choice to either agree with or modify managers' exclusions. Indeed, recent research suggests that managers influence the items that analysts exclude from street earnings (Christensen et al 2011; Black et al 2019). Further, Bentley et al (2018) find that managers' provision of pro forma earnings does not influence the quality of street earnings exclusions by analysts, which suggests that analysts do not exclusively rely on manager‐provided information to develop street earnings.…”

Section: Background and Research Questionsmentioning

confidence: 99%

“…Next, we examine whether managers' pro forma disclosures influence the quality of analysts' ETR exclusions. Prior research suggests that managers and analysts influence each other's non‐GAAP performance metrics (Black et al 2019; Christensen et al 2011; Chen, Chi, and Shevlin 2019; Chen, Chiu, Shevlin, and Wang 2019). When managers provide pro forma earnings, analysts have the choice to either agree with or modify managers' exclusions.…”

Section: Introductionmentioning

confidence: 99%

See 1 more Smart Citation

Street versus GAAP: Which Effective Tax Rate Is More Informative?*

Beardsley

Mayberry

McGuire

2021

Contemporary Accting Res

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This study investigates how sophisticated market participants use tax‐based information by examining whether analysts' street effective tax rates (ETRs) are informative. When assessing firm performance, analysts exclude items they believe do not reflect current performance, resulting in “street” metrics such as street ETR. However, evidence on the properties of the components of street earnings is limited. Examining the informativeness of street ETRs is important because taxes are a significant component of earnings, and the extent to which analysts understand taxes and incorporate them into their analyses is not clear. Using a hand‐collected sample of analyst reports, we find that while approximately 35% of street ETRs have at least one tax‐specific exclusion, over 90% reflect the tax effects of pre‐tax exclusions. Further, both tax‐specific exclusions and the tax effects of pre‐tax exclusions significantly contribute to differences between GAAP and street ETRs. Consistent with analysts' understanding of the implications of tax and nontax exclusions, our results suggest that street tax metrics exhibit greater predictive ability about future tax outcomes and provide more information to investors than GAAP tax metrics. We also find that ETR exclusions are of higher quality when the magnitude of the potentially excluded item is greater and when managers disclose pro forma earnings. Collectively, our findings suggest that analysts understand taxes, but selectively exert effort to incorporate tax‐based information into their assessment of firm performance. Our study should be informative to regulators and users of financial information because it provides evidence regarding the usefulness of street earnings metrics.

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How are Street Earnings Determined? Managers' Influence on Analysts' Exclusions and Agreement

Cited by 7 publications

References 50 publications

Has the Regulation of Non-GAAP Disclosures Influenced Managers’ Use of Aggressive Earnings Exclusions?

Has the Regulation of Non-GAAP Disclosures Influenced Managers’ Use of Aggressive Earnings Exclusions?

Disentangling Managers’ and Analysts’ Non‐GAAP Reporting

Street versus GAAP: Which Effective Tax Rate Is More Informative?*

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