US Managers' Use of ‘Pro Forma’ Adjustments to Meet Strategic Earnings Targets

Authors

  • Dirk E. Black,

    1. The authors are both from the School of Accountancy, Marriott School of Management, Brigham Young University, USA. They thank Erv Black, Ana Marques, and workshop participants at Brigham Young University for helpful comments on earlier drafts of the paper. They also appreciate helpful comments from the 2008 JBFA Capital Markets Conference participants, Martin Walker (editor), and an anonymous referee. Finally, they express appreciation to Bryan Graden for his valuable research assistance.
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  • Theodore E. Christensen

    Corresponding author
    1. The authors are both from the School of Accountancy, Marriott School of Management, Brigham Young University, USA. They thank Erv Black, Ana Marques, and workshop participants at Brigham Young University for helpful comments on earlier drafts of the paper. They also appreciate helpful comments from the 2008 JBFA Capital Markets Conference participants, Martin Walker (editor), and an anonymous referee. Finally, they express appreciation to Bryan Graden for his valuable research assistance.
      * Address for correspondence: Theodore E. Christensen, School of Accountancy, Marriott School of Management, Brigham Young University, 540 N. Eldon Tanner Building, Provo, UT 84602-3068, USA. e-mail: ted_christensen@byu.edu
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* Address for correspondence: Theodore E. Christensen, School of Accountancy, Marriott School of Management, Brigham Young University, 540 N. Eldon Tanner Building, Provo, UT 84602-3068, USA. e-mail: ted_christensen@byu.edu

Abstract

Abstract:  The practice of reporting manager-adjusted ‘pro forma’ earnings numbers in quarterly earnings press releases has attracted considerable attention in recent years in the United States. Prior research suggests that while some managers report these adjusted numbers to better reflect core earnings, others may use these earnings adjustments to meet strategic earnings targets on a pro forma basis when they fall short based on GAAP reporting standards. Assuming the latter motivation could potentially mislead investors, the difficulty lies in distinguishing the ‘good guys’ from the ‘bad guys.’ Using hand-collected pro forma earnings data, we investigate the extent to which different types of earnings adjustments affect the spread between pro forma earnings and GAAP earnings from continuing operations. Moreover, we investigate which types of adjustments managers use to meet strategic earnings targets. In addition to the exclusion of one-time items like restructuring charges, the results indicate that managers often exclude recurring expenses such as depreciation, research and development, and stock-based compensation to meet these strategic targets. The exclusion of recurring items is especially indicative of aggressive pro forma reporting. Finally, we find that firms that report adjusted earnings numbers only sporadically are more likely than firms that adjust earnings figures on a regular basis to use pro forma reporting to achieve strategic earnings targets by excluding recurring items.

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