Essays on the value relevance of earnings measures

Abstract

This dissertation presents two studies on the value relevance and perceived credibility of pro forma earnings. In the first study, I investigate the value relevance of pro forma earnings relative to two alternative earnings measures – GAAP earnings and analysts’ actual earnings. Value relevance is assessed using two approaches. The first approach examines whether the market’s expectations (contemporaneous returns or price) is best reflected in future pro forma earnings, future GAAP earnings, or future analyst’s actual earnings. The second approach is to determine through pair-wise comparisons of the three earnings measures (e.g., pro forma earnings versus GAAP earnings), which has the greatest explanatory power (comparing adjusted R2s) in explaining price and returns. Across approaches and models, each of the three earnings measures tends to be value relevant. However, Pro forma is consistently the most value relevant, followed by analysts’ actuals, with GAAP earnings having the least value relevance. That is, pro forma earnings have the greatest information content. This finding is consistent with managers, in aggregate, using pro forma to inform rather than to manage expectations or to mislead. In the second study, I examine the impact of credibility attributes – board characteristics, auditor quality and overall information quality – on the value relevance of pro forma earnings. It is hypothesized that the credibility attributes will have a statistically significant impact on investors’ reaction to pro forma earnings. Consistent with the predictions, I find that stronger board characteristics, higher auditor quality and higher overall information quality are positively associated with higher market reaction to the pro forma announcement. That is, credibility attributes increase the value relevance of pro forma earnings. This finding is consistent with some firms providing pro forma earnings that are perceived to be credible and others providing pro formas that are perceived as less credible and possibly provided to manage expectations or to mislead.