Reconciling GAAP Losses and Pro Forma Profits: Effects on Investor Judgments

W. Brooke Elliott
University of Illinois at Urbana–Champaign

Abstract: This study provides evidence that firms can lead non-sophisticated investors to make higher earnings performance judgments by emphasizing pro forma earnings in a quarterly press release. This evidence is the result of an experiment in which non-sophisticated and sophisticated investors analyze a firm’s first quarter earnings announcement in the form of a press release. Non-sophisticated investors who viewed pro forma earnings followed by GAAP earnings judged earnings performance to be higher than those who viewed either GAAP earnings alone or GAAP earnings followed by pro forma earnings. Sophisticated investors’ earnings judgments were not affected by the presence of pro forma earnings. Presenting a side-by-side reconciliation of GAAP and pro forma earnings mitigated the earnings performance judgments of non-sophisticated investors. Sophisticated investors’ earnings judgments were increased by a side-by-side reconciliation.

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