Does the Takeover Market Deter Opportunistic Non-GAAP Reporting?

Abstract

We exploit the Foreign Investment and National Security Act (FINSA) to examine the effect of an important managerial disciplining mechanism, the takeover market, on the quality of non-GAAP reporting. FINSA significantly reduced the likelihood of takeover for a large fraction of the CRSP-Compustat universe. We draw inferences using a difference-in-differences research design by contrasting non-GAAP disclosures by FINSAaffected firms with those of unaffected firms, before and after FINSA. We find that FINSA-affected firms more often exclude recurring expenses, more often exclude expenses incremental to those excluded by analysts, and more often use non-GAAP earnings to convert a GAAP-based miss of an earnings forecast to a beat, after FINSA. This effect accentuates predictably with the extent to which FINSA-affected firms are susceptible to the takeover market in the pre-FINSA period, and with the extent to which non-GAAP earnings determine manager compensation. We conclude by documenting a decline in non-GAAP earnings persistence and the value-relevance of non-GAAP earnings after FINSA. Our evidence demonstrates the role of the takeover market in curbing opportunistic non-GAAP reporting.