The Effects of Pro Forma Earnings Disclosures on Analysts' and Nonprofessional Investors' Equity Valuation Judgments

This paper presents an experiment that examines the effect of pro forma earnings disclosures on the judgments of analysts (i.e., more sophisticated investors) and nonprofessional (i.e., less sophisticated) investors. In the experiment, participants developed stock price assessments after reviewing background financial information and a current earnings announcement for a company. The earnings announcement was manipulated to report only GAAP earnings in one condition and both pro forma and GAAP earnings in the other condition. Consistent with empirical evidence, the pro forma earnings in our experiment exceeded GAAP earnings. The results indicate that nonprofessional investors who received an earnings announcement that contained both pro forma and GAAP disclosures assessed a higher stock price than did nonprofessionals who received an announcement containing only GAAP disclosures. Financial analysts' stock price judgments were not affected by the pro forma disclosures. Followup analyses suggest that analys...

[1]  Marc J. Leclere,et al.  Goodwill Amortization and the Usefulness of Earnings , 2000 .

[2]  Edward J. Joyce,et al.  Anchoring and Adjustment In Probabilistic Inference in Auditing , 1981 .

[3]  B. Lev,et al.  Fundamental Information Analysis , 1993 .

[4]  W. Edwards.  Human Cognitive Capabilities, Representativeness, and Ground Rules for Research* , 1983 .

[5]  Patrick E. Hopkins,et al.  The Effect of Financial Statement Classification of Hybrid Financial Instruments on Financial Analysts' Stock Price Judgments , 1996 .

[6]  Vicky B. Hoffman,et al.  Accountability, the dilution effect, and conservatism in auditors' fraud judgments , 1997 .

[7]  D. Eric Hirst,et al.  Comprehensive income reporting and analysts' valuation judgments , 1998 .

[8]  James F. Smith,et al.  The encoding and retrieval of numerical data for decision making in accounting contexts: Model development , 1995 .

[9]  Lisa Koonce,et al.  Investor Reactions to Financial Analysts' Research Reports , 1995 .

[10]  Linda S. McDaniel,et al.  Effects of Comprehensive‐Income Characteristics on Nonprofessional Investors' Judgments: The Role of Financial‐Statement Presentation Format , 2000 .

[11]  How Informative Are Earnings Numbers That Exclude Goodwill Amortization , 2001 .

[12]  D. A. Kenny,et al.  The moderator-mediator variable distinction in social psychological research: conceptual, strategic, and statistical considerations. , 1986, Journal of personality and social psychology.

[13]  Laureen A. Maines.  Judgment and decision-making research in accounting and auditing: Judgment and decision-making research in financial accounting: A review and analysis , 1995 .

[14]  The Joint Effect of Management's Prior Forecast Accuracy and the Form of Its Financial Forecasts on Investor Judgment , 1999 .

[15]  J. Hunton,et al.  Is Analyst Forecast Accuracy Associated with Accounting Information Use , 1999 .

[16]  Marinus J. Bouwman.  Human Diagnostic Reasoning by Computer: An Illustration from Financial Analysis , 1983 .

[17]  B. Fischhoff,et al.  Judgment under uncertainty: Debiasing , 1982 .

[18]  Robert Libby,et al.  Analysts' reactions to warnings of negative earnings surprises , 1999 .

[19]  Steven M. Glover.  The influence of time pressure and accountability on auditors' processing of nondiagnostic information , 1997 .

[20]  James E. Hunton,et al.  Analysts' Reactions to Earnings Preannouncement Strategies , 2002 .

[21]  Barbara A. Lougee,et al.  Earnings Quality and Strategic Disclosure: An Empirical Examination of 'Pro Forma' Earnings , 2002 .

[22]  D. Read.  Judgment and Choice , 2005 .

[23]  Thomas Kida,et al.  The effects of encoded memory traces for numerical data on accounting decision making , 1998 .

[24]  David Mazursky,et al.  Training Novice Investors to Become More Expert: The Role of Information Accessing Strategy , 2001 .

[25]  R. Nisbett,et al.  The dilution effect: Nondiagnostic information weakens the implications of diagnostic information , 1981, Cognitive Psychology.

[26]  Herbert A. Simon,et al.  The new science of management decision , 1960 .

[27]  Assessing the Relative Informativeness and Permanence of Pro Forma Earnings and GAAP Operating Earnings , 2003 .

[28]  A. Tversky,et al.  Judgment under Uncertainty: Heuristics and Biases , 1974, Science.

[29]  D Kahneman,et al.  On the reality of cognitive illusions. , 1996, Psychological review.

[30]  Marinus J. Bouwman,et al.  How do financial analysts make decisions? A process model of the investment screening decision , 1987 .

[31]  Karl E. Hackenbrack.  Implications Of Seemingly Irrelevant Evidence In Audit Judgment , 1992 .

[32]  Thomas Kida,et al.  Heuristics and biases: Expertise and task realism in auditing. , 1991 .