Non-GAAP Reporting and Investment

The wide-spread reporting of non-GAAP earnings suggests efficiency gains from doing so. By estimating a dynamic investment model, we examine the real implications of investors using both GAAP and non-GAAP earnings to value firms. When investors use the firm’s GAAP earnings only, the firm’s manager—who cares about current stock prices— underinvests, and his investment is sensitive to transitory earnings. Non-GAAP earnings can improve investment efficiency by adjusting for these transitory earnings, but can also hide inefficient investment by introducing opportunistic bias. Although non-GAAP earnings induce overinvestment, they dominate GAAP-only reporting. Counterfactual analysis reveals supplementing GAAP earnings with biased non-GAAP earnings increases firm value by 3.4% relative to GAAP-only reporting. Precluding bias reduces overinvestment and further increases firm value by 1%.