Who Trades on Pro Forma Earnings Information?

In recent years, many companies have emphasized adjusted-GAAP earnings numbers in their quarterly press releases. While managers use different names to describe these non-standard earnings metrics, the financial press frequently refers to them as pro forma earnings. Managers and other advocates of pro forma reporting argue that these disclosures provide a clearer picture of companies\u27 core earnings. On the other hand, regulators, policymakers, and the financial press often allege that managers\u27 pro forma earnings disclosures are opportunistic attempts to mislead investors. Recent evidence suggests that while many pro forma earnings disclosures are altruistically motivated, some may represent managers\u27 attempts to portray overly-optimistic financial performance. If this is the case, less-wealthy, less-sophisticated, individual investors are arguably the most at risk of being misled. Consequently, this study investigates who trades on pro forma earnings information. Our intraday investigation of transactions around earnings announcements containing pro forma earnings information reveals that less-sophisticated investors\u27 announcement-period abnormal trading is significantly positively associated with the magnitude and direction of the earnings surprise based on pro forma earnings. In contrast, we find no association between sophisticated investors\u27 trading and manager-reported pro forma information. Overall, our analyses and numerous robustness tests suggest that the segment of the market that relies on pro forma earnings information is populated predominantly by less-sophisticated individual investors. This evidence is particularly relevant to standard setters and regulators given that Section 401(b) of the Sarbanes-Oxley Act of 2002 and subsequent SEC regulations are specifically designed to protect ordinary investors from misleading pro forma information