Page 229 - 34-2
P. 229

NTU Management Review Vol. 34 No. 2 Aug. 2024




               Securities and Exchange Commission (SEC) implemented Regulation G in 2003 to govern
               firms’ non-GAAP disclosures. Specifically, this rule prohibits firms from adjusting a
               non-GAAP measure to eliminate items identified as non-recurring when such items are
               reasonably likely to recur within two years or a similar charge or gain occurred within the

               prior two years. Many studies find that following the passage of Regulation G, the quality
               of non-GAAP exclusions improves and the tendency to meet or beat analyst forecasts
               using non-GAAP earnings declines (Heflin and Hsu, 2008; Kolev, Marquardt, and McVay,

               2008). Nonetheless, the frequency of non-GAAP earnings disclosure also significantly
               decreases (Entwistle, Feltham, and Mbagwu, 2006; Heflin and Hsu, 2008; Marques, 2006).
               Furthermore, Regulation G does not eliminate the opportunistic component of non-GAAP
               reporting because firms may increase their incentives to achieve earnings targets through
               special items (Baumker, Biggs, McVay, and Pierce, 2014; Kolev et al., 2008).

                   In 2010, the SEC issued new Compliance and Disclosure Interpretations (C&DIs)
               on the use of non-GAAP earnings that relaxed the rigorous Regulation G guidelines. This
               new rule gives firms more discretion in determining how to adjust for recurring items.

               Although the release of C&DIs is an economically important event that may shape firms’
               disclosure practices (Kyung and Weintrop, 2016), fewer studies examine the consequences
               of this new regulation.
                   Cain, Kolev, and McVay (2020) argue that special items may contain opportunistically
               misclassified recurring expenses that are not truly transitory. Accordingly, they propose a

               methodology to predict economically driven special items, the excess of which are referred
               to as opportunistic special items. Considerable literature has established that companies
               often exclude special items to meet earnings benchmarks or design compensation contracts

               (Donelson, Jennings, and McInnis, 2011; Fairfield, Kitching, and Tang, 2009; Kolev
               and Potepa, 2019). However, these studies do not explore how a change in non-GAAP
               regulation influences firms’ strategic reporting of special items.
                   Besides, Guggenmos, Rennekamp, Rupar, and Wang (2022) provide experimental
               evidence that increased regulatory attention to non-GAAP earnings can result in more

               aggressive GAAP earnings management and reduced GAAP earnings quality. Given that
               C&DIs relax the restrictions of Regulation G and give firms more discretion in adjusting
               recurring items, we expect that this less stringent regulation will lower the incentives of

               non-GAAP reporting firms to manage earnings through the recognition of opportunistic


                                                     221
   224   225   226   227   228   229   230   231   232   233   234