Non-GAAP Reporting and Investment

The wide-spread reporting of non-GAAP earnings suggests efficiency gains from doing so. Byestimating a dynamic investment model, we examine the real implications of investors using both GAAP and non-GAAP earnings to valuefirms. When investors use thefirm's GAAP earnings only, thefirm's manager-who caresabout current stock prices-underinvests, and his investment is sensitive to transitory earnings. Non-GAAP earningscan improve investment efficiency by adjusting for these transitory earnings, but can also hide inefficient investmentby introducing opportunistic bias. Although non-GAAP earnings induce overinvestment, they dominate GAAP-onlyreporting. Counterfactual analysis reveals supplementing GAAP earnings with biased non-GAAP earnings increasesfirm value by 3.4 percent relative to GAAP-only reporting. Precluding bias reduces overinvestment and furtherincreasesfirm value by 1 percent.