The Circumstances and Legal Consequences of Non†GAAP Reporting: Evidence from Restatements

Our study examines the circumstances of non†GAAP financial reporting by 492 U.S. companies that announced restatements from 1995 to 1999. We focus on income statements to analyze the occurrence and resolution of litigation over restatements and explore the role of accounting items in bringing and resolving this litigation. We provide evidence on the pervasiveness of accounting misstatements, describe their nature, and show how, if at all, they affect litigation. We assess the nature of restatements by determining whether regular, recurring earnings from primary operations (core) or other components of earnings (noncore) are misstated, and we assess their pervasiveness by estimating the number of primary accounts misstated. In our sample, companies with core restatements have higher frequencies of intentional misstatements (fraud) and subsequent bankruptcy or delisting. Likewise, these companies have, on average, more material misstatements, more negative security price reactions to restatement announcements, and more negative security price changes over the six months preceding and following restatement announcements. However, controlling for these and other factors, we find a significant association between accounting items and litigation, whether occurrences or resolutions. Specifically, core restatements — driven primarily by misstatements of revenue, a component of core earnings — and more pervasive restatements each play a role, while misstatements of noncore earnings alone do not.