Economic Policy Uncertainty and Firms’ Non-GAAP Reporting

Abstract

Using the US economic policy uncertainty (EPU) index developed by Baker, S. R., Bloom, N., & Davis, S. J. [2016. Measuring economic policy uncertainty. The Quarterly Journal of Economics, 131(4), 1593–1636. https://doi.org/10.1093/qje/qjw024], we examine the impact of policy uncertainty on firms’ non-GAAP reporting practices. We show that EPU increases both the likelihood and quality of non-GAAP earnings disclosures. These effects are more pronounced for firms with higher index ownership and for those with less informative GAAP earnings. Furthermore, we show that non-GAAP disclosures provide tangible economic benefit during periods of increasing EPU, including compensating for the reduced informativeness of GAAP earnings and reducing information asymmetry. Overall, our evidence suggests that non-GAAP reporting is a means by which managers communicate value-relevant information about their firms’ performance to investors during periods of high EPU.

Keywords:

• Economic policy uncertainty
• Earnings informativeness
• Non-GAAP earnings disclosure
• Information asymmetry
• Investor information demand

Acknowledgments

We thank two anonymous referees, Beatriz Garcia Osma (editor), Hervé Stolowy (editor), Paul Zarowin (editor) for their guidance through the review process, and Jeong-Bon Kim, Ting Zhang, Haibin Wu and participants of research seminars/workshops at the Australian National University, Harbin Institute of Technology (Shenzhen), Huazhong University of Science and Technology, Shanghai University of Finance and Economics, South China University of Technology for their comments.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Supplemental Data and Research Materials

Supplemental data for this article can be accessed on the Taylor & Francis website, doi:10.1080/09638180.2024.2368721.

• Appendix B. Addressing time-series concern

• Appendix C. Change analyses: EPU and non-GAAP disclosure

• Appendix D. OLS regression: EPU and the likelihood of non-GAAP disclosure

• Appendix E. The influence of firms’ transitory items

• Appendix F. EPU and the aggressiveness of non-GAAP earnings

• Appendix G. Firms’ exposure to EPU

Notes

1 The common types of recurring items are depreciation and amortization costs, stock-based compensation costs, R&D expenses, and tax-related costs; the common types of nonrecurring items are restructuring charges, gains and losses on sales of assets, and merger and acquisition costs (Bhattacharya et al., 2003; Black & Christensen, 2009; Brown et al., 2012).

2 The value of distinguishing between recurring and transitory items to provide insights into both current and future performance aligns with findings from ongoing studies (Bhattacharya et al., 2003; Bradshaw et al., 2018; Christensen et al., 2019; Heflin et al., 2024). These exclusions also suggest managerial approaches to risk as indicated by realized investment gains or losses (Campbell, 2015). They discover that non-GAAP earnings are more relevant to risk than GAAP earnings, both in terms of reflecting existing firm risks and indicating potential future risks. Moreover, exclusions, albeit to a lesser degree, also bear relevance in this context.

4 To address the concern that our results could be driven by a generally upward trend over time in both policy uncertainty and non-GAAP reporting, we conduct several robustness tests. First, using the sub-sample from 2010 onwards, we estimate the main regression and find our results remain unchanged. In addition, we partition the sample into two distinct time periods, characterized by an increase and a decrease in EPU. We find that whether in periods of increased or decreased policy uncertainty, the EPU index is positively associated with firms’ propensity to disclose non-GAAP reporting. We show the results of these two robustness tests in Appendix B. In Appendix C, we perform two change analyses, focusing on the change in non-GAAP issuance decisions and the change in the percentage of firms reporting non-GAAP earnings. The results show that change in the BBD index is significantly positively associated with the two aforementioned variables.

5 To address the concern that our findings are affected by an incidental parameter problem caused by logistic estimation, we additionally conduct OLS regression concerning the non-GAAP earnings disclosure propensity in Appendix D. The results show that the estimated coefficient of EPU remains positive and significant.

6 An alternative explanation for an increase in non-GAAP earnings disclosure propensity would be that the firm’s transitory items increase under high policy uncertainty. To address this possibility, we first examine the effect of EPU on firms’ transitory items in Appendix E Panel A, and we find that EPU does not increase transitory items. Second, we conduct subsample analysis based on the firm’s transitory items in Appendix E Panel B. The results show that the estimated coefficients of EPU in the two subsamples are both positive and significant, which indicates that our main findings are driven by managerial discretion to provide more information rather than the real economic effects of policy uncertainty.

Additional information

Funding

Xia Chen acknowledges financial support from the ‘Fundamental Research Funds for the Central Universities’ Zhongnan University of Economics and Law (grant number 2722022BQ036).