Who Trades on Pro Forma Earnings Information

By Nilabhra Bhattacharya, Ervin L. Black, Theodore E. Christensen, Richard D. Mergenthaler. 2004

229 citations recorded by the source corpus.

In recent years, many companies have emphasized adjusted-GAAP earnings numbers in their quarterly press releases. While managers use different names to describe these non-standard earnings metrics, the financial press frequently refers to them as "pro forma" earnings. Managers and other advocates of pro forma reporting argue that these disclosures provide a clearer picture of companies' core earnings. On the other hand, regulators, policymakers, and the financial press often allege that managers' pro forma earnings disclosures are opportunistic attempts to mislead investors. Recent evidence suggests that while many pro forma earnings disclosures are altruistically motivated, some may represent managers' attempts to portray overly-optimistic financial performance. If this is the case, less-wealthy, less-sophisticated, individual investors are arguably the most at risk of being misled. Consequently, this study investigates who trades on pro forma earnings information. Our intraday investigation of transactions around earnings announcements containing pro forma earnings information reveals that less-sophisticated investors' announcement-period abnormal trading is significantly positively associated with the magnitude and direction of the earnings surprise based on pro forma earnings. In contrast, we find no association between sophisticated investors' trading and manager-reported pro forma information. Overall, our analyses and numerous robustness tests suggest that the segment of the market that relies on pro forma earnings information is populated predominantly by less-sophisticated individual investors. This evidence is particularly relevant to standard setters and regulators given that Section 401(b) of the Sarbanes-Oxley Act of 2002 and subsequent SEC regulations are specifically designed to protect ordinary investors from misleading pro forma information.

Subfields: Accounting, Finance

View Paper: https://www.semanticscholar.org/paper/d0eae0448e2ade2133110f8fd73f09a4791c5515

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Citations in the corpus

Signaling Firm Performance Through Financial Statement Presentation: An Analysis Using Special Items* : Financial Statement Presentation (2009, unknown): “Finally, we provide evidence that managers’ presentation decisions for this subset of reporting elements does capture differing economic qualities, consistent with observed user behaviors surrounding such decisions in experimental settings (e.g., Hirst and Hopkins 1998; Bhattacharya et al. 2007).”
Non-GAAP earnings and board independence (2011, background): “Along these lines, Bhattacharya et al. (2007) find that non-GAAP earnings influence the trades of less sophisticated investors, in particular.”
Why Do Individual Investors Disregard Accounting Information? The Roles of Information Awareness and Acquisition Costs (2018, unknown): “This assumption and research design have extensive precedent (e.g., Woodruff and Senchack 1988; Bhattacharya 2001; Battalio & Mendenhall 2005; Cready & Hurtt 2002; Bhattacharya et al. 2007; Hirshleifer et al. 2008), but we acknowledge that they are imperfect.”
Do Security Analysts Speak in Two Tongues (2009, unknown): “See also Bhattacharya et al. (2007), who find that small traders respond strongly to IBES-based earnings surprises, while large traders do not.”
Female CEOs and Core Earnings Quality: New Evidence on the Ethics Versus Risk-Aversion Puzzle (2018, unknown): “Arguably, managers are motivated to inflate their core earnings rather than the bottom-line net income because most investors currently base their investment decisions on this number (Bhattacharya et al. 2007; Bradshaw and Sloan 2002; Elliott 2006).”
Trading Volume Around Earnings Announcements and Other Financial Reports: Theory, Research Design, Empirical Evidence, and Directions for Future Research (2010, unknown): “…trading, intradaily trading allows us to investigate who is trading on various disclosures (e.g., Cready and Mynatt 1991; Asthana et al. 2004; Bhattacharya et al. 2007), and to explore how earnings expectations differ across small versus large traders (e.g., Bhattacharya 2001; Battalio and…”
Investor Trading and the Post Earnings Announcement Drift (2011, unknown): “10 whereas other studies present evidence consistent with small traders representing individual investors (Easley and O’Hara 1987; Lee 1992; Franco et al. 2007; Bhattacharya et al. 2007; Ayers et al. 2008).”