Does Pro Forma Reporting Bias Analyst Forecasts?

Abstract

Standard setters put much effort into the development of ‘better’ financial reporting standards, that is, standards that more accurately capture the economic substance of business activities. However, the more sophisticated accounting treatments caused by new standards, and the growing complexity of business activities as such, has made financial reports more difficult to understand. In response to this situation, some companies use pro forma reporting, which means that certain complex items required by financial reporting standards are excluded. This study adopts a user perspective and investigates how pro forma reporting affects analysts' judgments in an experimental setting. On the basis of psychological theory, our hypothesis suggests that analysts' judgments will be affected by differences in the way company performance is presented. Our results show that analysts who received both pro forma and Generally Accepted Accounting Principles (GAAP) information made significantly higher earnings per share (EPS) forecasts than those who received GAAP information only. It is argued that positive framing and higher levels of anchor explain this result, which suggests in turn that analysts' EPS forecasts can be manipulated by alternative ways of presenting company performance. Some possible implications of this finding for standard setters are discussed.

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