Non-GAAP earnings and executive compensation: An experiment

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Abstract

Prior literature suggests investors react to the presence, presentation, and prominence of non-GAAP earnings disclosures. We extend this literature by considering the purpose of non-GAAP earnings disclosures and their effect on investors’ judgments and decisions. Employing an experiment, we manipulate the role non-GAAP earnings plays in determining executive compensation. We find when non-GAAP earnings are used to determine executive compensation, investors assign a higher evaluation of corporate financial performance and invest significantly more capital. Consistent with attribution theory, our mediation model finds that the use of non-GAAP earnings to remunerate executives strengthens the informative perception of non-GAAP earnings disclosures, which in turn influences their evaluation and investment decision. Investors’ judgments are consistent in both the GAAP loss and GAAP profit scenarios. Contrary to prior literature, we find investors intentionally rely on non-GAAP earnings in their decision making. These findings support the regulation of non-financial information complementing non-GAAP financial measures.
Original languageEnglish
Publication statusUnpublished - Apr 2022

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