A rating system to evaluate non-GAAP exclusion quality

• Main Authors: DECHOW, Patricia M., LOH, Wei Ting, WANG, Annika Yu
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2024
• Subjects: Analyst Forecast Dispersion; on-GAAP Exclusion Quality; Non-GAAP Reporting; Recurring Expenses; Regulation G; SEC Comment Letters; Accounting; Corporate Finance
• Online Access: https://ink.library.smu.edu.sg/soa_research/2054; https://ink.library.smu.edu.sg/context/soa_research/article/3081/viewcontent/s11142_024_09855_3_pvoa_cc_by.pdf
• Institution: Singapore Management University

We develop a rating system to evaluate the quality of individual non-GAAP exclusions. Our perspective is that high-quality exclusions reflect nonrecurring economic transactions, are transitory accounting adjustments, or have little usefulness in forecasting cash flows. We use four approaches to rate exclusions. We evaluate the serial correlation of the exclusion, survey accounting academics’ views, obtain practitioner ratings from the CFA Institute, and identify the exclusions approved by the Chinese securities regulator. A firm’s exclusion quality score is the weighted average rating of its individual exclusions. For our sample of S&P 500 firms, we document that exclusion quality varies by industry, captures trends in non-GAAP reporting, and is reasonably stable at the firm level. To validate the rating, we show that firms with lower exclusion quality scores receive more SEC comment letters, incur more Regulation G violations, exhibit greater analyst forecast dispersion, and have slower price discovery following earnings announcements.