Taxes in non-GAAP reporting: Evidence of strategic behavior in selecting tax rates applied to exclusions

Management Science, Forthcoming

47 Pages Posted: 6 Aug 2019 Last revised: 17 Dec 2021

See all articles by Novia (Xi) Chen

Novia (Xi) Chen

University of Houston - Department of Accountancy & Taxation

Peng-Chia Chiu

The Chinese University of Hong Kong, Shenzhen

Terry J. Shevlin

University of California-Irvine; University of California-Irvine

Jiani Wang

University of International Business and Economics (UIBE)

Date Written: December 16, 2021

Abstract

When reporting after-tax non-GAAP earnings, firms are required to adjust for the tax effects of exclusions. Since 2010, the SEC has issued and updated Compliance and Disclosure Interpretations (hereafter, C&DIs) which specifically require firms to disclose the tax effects of exclusions. We assemble a detailed, hand-collected dataset of S&P 1500 firms’ disclosures to provide the first large-sample evidence on the reporting of the tax effects of non-GAAP exclusions. We find three key results. First, echoing the SEC’s concern, a significant proportion of non-GAAP reporting firms do not follow the C&DIs’ guidelines (i.e., they do not disclose the tax effects of exclusions). Second, among firms that disclose the tax effects of exclusions, we find that managers strategically select the tax rates applied to exclusions to achieve after-tax earnings targets. Third, manager-reported non-GAAP earnings are less persistent for future operating earnings and cash flows, relative to non-GAAP earnings calculated by applying various benchmark tax rates to exclusions. This evidence suggests that managers’ strategic behavior in selecting the tax rates applied to exclusions pollutes reported non-GAAP earnings and reduces their usefulness for predicting future performance. Overall, our results shed light on a specific channel through which firms use non-GAAP reporting to meet or beat earnings expectations.

Keywords: non-GAAP earnings, disclosure, income taxes, meet or beat analysts' forecasts

Suggested Citation

Chen, Novia (Xi) and Chiu, Peng-Chia and Shevlin, Terry J. and Shevlin, Terry J. and Wang, Jiani, Taxes in non-GAAP reporting: Evidence of strategic behavior in selecting tax rates applied to exclusions (December 16, 2021). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3430796 or http://dx.doi.org/10.2139/ssrn.3430796

Novia (Xi) Chen (Contact Author)

University of Houston - Department of Accountancy & Taxation ( email )

Bauer College of Business
4800 Calhoun Road
Houston, TX 77204
United States

Peng-Chia Chiu

The Chinese University of Hong Kong, Shenzhen ( email )

Terry J. Shevlin

University of California-Irvine ( email )

Paul Merage School of Business
Irvine, CA California 92697-3125
United States
2065509891 (Phone)

University of California-Irvine ( email )

Paul Merage School of Business
Irvine, CA 92697-3125
United States
949-824-6149 (Phone)

Jiani Wang

University of International Business and Economics (UIBE) ( email )

10, Huixin Dongjie
Changyang District
Beijing, Beijing 100029
China

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