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The Predictive Value of Expenses Excluded from Pro Forma Earnings

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  • Jeffrey T. Doyle

    (University of Michigan Business School)

  • Russell J. Lundholm

    (University of Michigan Business School)

  • Mark T. Soliman

    (University of Michigan Business School)

Abstract

We investigate the informational properties of pro forma earnings. This increasingly popular measure of earnings excludes certain expenses that the company deems non-recurring, non-cash, or otherwise unimportant for understanding the future value of the firm. We find, however, that these expenses are far from unimportant. Higher levels of exclusions lead to predictably lower future cash flows. We also find that investors do not fully appreciate the lower cash flow implications at the time of the earnings announcement. A trading strategy based on the excluded expenses yields a large positive abnormal return in the years following the announcement, and persists after controlling for various risk factors and other anomalies.

Suggested Citation

  • Jeffrey T. Doyle & Russell J. Lundholm & Mark T. Soliman, 2003. "The Predictive Value of Expenses Excluded from Pro Forma Earnings," Review of Accounting Studies, Springer, vol. 8(2), pages 145-174, June.
    • Handle: RePEc:spr:reaccs:v:8:y:2003:i:2:d:10.1023_a:1024472210359
    DOI: 10.1023/A:1024472210359
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    Cited by:

    1. Richard Frankel & William J. Mayew & Yan Sun, 2010. "Do pennies matter? Investor relations consequences of small negative earnings surprises," Review of Accounting Studies, Springer, vol. 15(1), pages 220-242, March.
    2. Theodore E. Christensen, 2012. "Discussion of “Why do pro forma and street earnings not reflect changes in GAAP? Evidence from SFAS 123R”," Review of Accounting Studies, Springer, vol. 17(3), pages 563-571, September.
    3. David Aboody & Reuven Lehavy & Brett Trueman, 2010. "Limited attention and the earnings announcement returns of past stock market winners," Review of Accounting Studies, Springer, vol. 15(2), pages 317-344, June.
    4. Kevin Ke Li, 2011. "How well do investors understand loss persistence?," Review of Accounting Studies, Springer, vol. 16(3), pages 630-667, September.
    5. Theodore E. Christensen & Kenneth J. Merkley & Jennifer Wu Tucker & Shankar Venkataraman, 2011. "Do managers use earnings guidance to influence street earnings exclusions?," Review of Accounting Studies, Springer, vol. 16(3), pages 501-527, September.
    6. Richard Frankel & Sarah McVay & Mark Soliman, 2011. "Non-GAAP earnings and board independence," Review of Accounting Studies, Springer, vol. 16(4), pages 719-744, December.
    7. Young-Soo Choi & Stephen Lin & Martin Walker & Steven Young, 2007. "Disagreement over the persistence of earnings components: evidence on the properties of management-specific adjustments to GAAP earnings," Review of Accounting Studies, Springer, vol. 12(4), pages 595-622, December.
    8. Mary E. Barth & Ian D. Gow & Daniel J. Taylor, 2012. "Why do pro forma and Street earnings not reflect changes in GAAP? Evidence from SFAS 123R," Review of Accounting Studies, Springer, vol. 17(3), pages 526-562, September.
    9. Patricia M. Dechow & Weili Ge, 2006. "The persistence of earnings and cash flows and the role of special items: Implications for the accrual anomaly," Review of Accounting Studies, Springer, vol. 11(2), pages 253-296, September.
    10. Lynn Rees, 2005. "Abnormal Returns from Predicting Earnings Thresholds," Review of Accounting Studies, Springer, vol. 10(4), pages 465-496, December.
    11. Frank Heflin & Charles Hsu & Qinglu Jin, 2015. "Accounting conservatism and Street earnings," Review of Accounting Studies, Springer, vol. 20(2), pages 674-709, June.
    12. Chih-Ying Chen, 2010. "Do analysts and investors fully understand the persistence of the items excluded from Street earnings?," Review of Accounting Studies, Springer, vol. 15(1), pages 32-69, March.
    13. Daniel W. Collins & Oliver Zhen Li & Hong Xie, 2009. "What drives the increased informativeness of earnings announcements over time?," Review of Accounting Studies, Springer, vol. 14(1), pages 1-30, March.
    14. Patricia M. Fairfield & Karen A. Kitching & Vicki Wei Tang, 2009. "Are special items informative about future profit margins?," Review of Accounting Studies, Springer, vol. 14(2), pages 204-236, September.
    15. Julia D’Souza & K. Ramesh & Min Shen, 2010. "Disclosure of GAAP line items in earnings announcements," Review of Accounting Studies, Springer, vol. 15(1), pages 179-219, March.
    16. Mark T. Bradshaw, 2011. "A discussion of “Do managers use earnings guidance to influence street earnings exclusions?”," Review of Accounting Studies, Springer, vol. 16(3), pages 528-538, September.
    17. Ana Marques, 2006. "SEC interventions and the frequency and usefulness of non-GAAP financial measures," Review of Accounting Studies, Springer, vol. 11(4), pages 549-574, December.

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