An empirical analysis of non-GAAP measures for high-litigation-risk industries

Abstract

This study empirically examines the effects of litigation risk on the likelihood and quality of non-GAAP reporting. Results suggest that firms in industries with a high incidence of litigation are more likely to disclose non-GAAP earnings than those in other industries, while the extent of the non-GAAP exclusion per share (the magnitude of the difference between non-GAAP earnings and GAAP earnings) decreases for high-litigation-risk firms. In addition, we investigate the relations between the extent of non-GAAP reporting during two distinct periods of financial stress: the financial crisis of 2008–2009 and the COVID-19 pandemic year of 2020. Results of these tests show that while the magnitude of non-GAAP exclusions generally increased during these periods, exclusions for high-litigation-risk firms were lower relative to other industries. We rationalize these findings by asserting that litigation risk incentivizes managers to disclose high-quality non-GAAP earnings.