Essays on Auditor Quality and Non-GAAP Earnings

This proposal incorporates three essays on voluntary, non-GAAP earnings disclosure. The first essay reviews the non-GAAP earnings literature. Given the discussion on non-GAAP earnings and the increasing concerns from the regulators (i.e., SEC and PCAOB), research investigating the determinants and the incentives related to non-GAAP earnings is rapidly expanding. This essay synthesizes the prior research and summarizes the determinants found to be significantly related to non-GAAP earnings disclosure and quality, as well as the incentives related to each determinant. In addition, I will discuss possible future research related to the non-GAAP incentives.

The second essay provides empirical evidence on whether high quality auditors motivate or constrain opportunistic non-GAAP earnings. Preliminary results are consistent with managers using non-GAAP earnings opportunistically when they have a high quality auditor over their financial statements (GAAP earnings). Specifically, using hand-collected non-GAAP earnings disclosure in firms’ annual press releases, I first document that firms with industry expert auditors are more likely to engage in non-GAAP earnings disclosure. Further, I find that firms with high quality auditors have low quality non-GAAP exclusions. However, I do not find a significant relationship between auditor quality and non-GAAP earnings meeting or beating financial benchmarks when GAAP earnings fail to do so. Taken together, the results are consistent with the apparent concern of the PCAOB in proposing auditors start providing assurance on non-GAAP earnings.

The third essay studies the joint effect of the board of directors/audit committee and the auditor on non-GAAP earnings disclosure. Prior research has found the BOD/AC are effective at constraining opportunistic non-GAAP earnings, while in Essay II, results suggest that firms with high quality auditors are more likely to disclose non-GAAP earnings opportunistically. The opposing effects of BOD/AC and auditors on non-GAAP earnings provide a unique setting to investigate which of two monitoring functions has the dominating effect of manager’s non-GAAP earnings decision. The evidence will shed light on the relationship between two monitors of a firm’s financial reporting, and contributes to the corporate governance literature.

Many thanks to Christine’s Proposal Defense committee:

Committee Chair: Barbara Grein, Ph.D. Associate Professor of Accounting Committee Member: Hsihui Chang, Ph.D. KPMG Professor of Accounting Committee Member: Thomas Chiang, Ph.D. Marshall M. Austin Professor of Finance Committee Member: Natalya Khimich, Ph.D. Assistant Professor of Accounting Committee Member: Mark Vargus, Ph.D. Assistant Professor of Accounting