Non-GAAP Earnings Disclosure and the Valuation of IPOs
We investigate the disclosure of non-GAAP earnings metrics in IPO prospectuses and how these disclosures affect IPO valuation. While the likelihood of non-GAAP reporting has continued to increase among public firms, we find an initial increase, but later a decline in the disclosure of non-GAAP performance metrics among IPO firms in recent years, suggesting that SEC scrutiny of IPO prospectuses has caused some managers to think twice about their disclosure. Our valuation tests indicate that IPO firms disclosing non-GAAP earnings metrics generally exhibit higher offer values and less undervaluation during the IPO process. We also find that adjusted earnings information is value-relevant and associated with higher IPO valuations. Our evidence indicates that the earnings exclusions made by IPO firms are appropriately weighted by investors in the IPO valuation process. A detailed analysis of issuers’ earnings exclusions reveals that IPOs exhibit higher valuations when prospectuses contain non-GAAP metrics with uncommon earnings exclusions as well as add-backs to revenue (which are less justifiable according to regulatory views). Additional analyses suggest that IPO valuations are lower across all stages of the pricing process for non-GAAP IPOs that elect to file reduced disclosures as an emerging growth company under the 2012 JOBS Act, suggesting that non-GAAP exclusions, and especially recurring exclusions, can help to mitigate undervaluation for small issuers that are more informationally opaque.