The value relevance of a non‐GAAP performance metric to the capital markets

Purpose - The study is driven by concerns raised by standard setters and others about the usefulness of performance reporting under generally accepted accounting principles (GAAP). Of primary interest is whether explicitly defining what information should be included in earnings results in an earnings measure that is more relevant than operating earnings computed according to current GAAP. The purpose of this paper is to explore whether reducing management discretion in the reporting of performance adds to the value relevance of the performance measures reported to capital markets. Design/methodology/approach - The value relevance of this non‐GAAP earnings measure is examined by estimating market valuation and returns models for 518 US firms included in the Standard & Poor's 500 Index over the time period 2002‐2007. Findings - Results show that the explicitly defined non‐GAAP measure used is significantly associated with equity market values and returns and is significantly more value‐relevant than the GAAP measure. Originality/value - The paper contributes to accounting literature assessing the relevance of earnings in setting equity market value. More specifically, it provides evidence consistent with prior results that non‐GAAP performance measures are more useful in valuation than GAAP earnings. However, in contrast with prior studies, the more explicit performance measure the paper examines removes some of the classificatory discretion pervasive in other non‐GAAP earnings metrics.