Professional Documents
Culture Documents
Does Pro Forma Reporting Bias Analyst Forecasts?: Patric Andersson & Niclas Hellman
Does Pro Forma Reporting Bias Analyst Forecasts?: Patric Andersson & Niclas Hellman
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.
1. Introduction
There is a general international trend towards increasingly complex accounting.
Pro forma reporting, that excludes some of the complex GAAP-required items,1
offers a way of demystifying complex accounting disclosures to allow for better
communication of a company’s ‘core earnings’ (Bhattacharya et al., 2004). Pro
forma reporting started in the USA in the mid-1990s (Bhattacharya et al.,
2003), and has since been adopted by many companies, including large non-
US companies such as Nokia and British Telecom.
The pro forma adjustments generally lead to improved results (Bradshaw and
Sloan, 2002),2 and critics of pro forma reporting claim that it is simply a way of
increasing profits to make a company look more attractive to analysts and inves-
tors. Doyle et al. (2003) report that expenses excluded by the calculation of pro
forma earnings are negatively related to future cash flows, which indicates that
the items excluded from the pro forma statement are in fact relevant to analysts
and investors. If the users of accounting information do not accept the complex
GAAP reports, but rely on simplified and improved pro forma numbers, their
judgment may be biased. However, experimental research (Frederickson and
Miller, 2004; Elliott, 2006) indicates that professional users (i.e. financial ana-
lysts) are able to ‘see through’ the pro forma adjustments, and their judgment
does not become biased. The main purpose of the present study is to test
whether this finding also holds for settings in which there is substantial difference
between (negative) pro forma and (positive) pro forma earnings. Thirty-six
Swedish financial analysts in an experimental setting were given fourth-quarter
earnings releases for an anonymous listed company, and were asked to forecast
the next year’s earnings per share (EPS) according to Swedish GAAP. One
group of analysts was given GAAP information only, while another group
received both pro forma and GAAP information. The results show that the ana-
lysts who were given both pro forma and GAAP information made significantly
higher EPS (according to GAAP) forecasts, compared to the analysts who
received GAAP information only. If an alternative (non-GAAP) presentation
of a company’s performance draws attention away from GAAP numbers in
such a way as to make sophisticated users change their judgment, as our
results suggest, this represents a potential threat to the public’s trust in account-
ing, in that managers may modify the pro forma reporting in an opportunistic
way. We suggest that standard setters should be concerned about the proliferation
of pro forma earnings and about their presentation and use by various parties.
In Sweden, the new listing rules on the Stockholm Stock Exchange require
companies to include three specific GAAP-measured items (turnover, net
profit and earnings per share) at the beginning of their earnings releases
(Stockholmsbörsen, 2003).
280 P. Andersson & N. Hellman
(Pitt, 2001)
The argument that pro forma reporting satisfies the need of investors and analysts
for simplified reporting geared to the core earnings has received support in
market-based accounting research. Bradshaw and Sloan (2002, p. 64) conclude
that investors display a growing preference for the modified versions of profits
reported by the analyst tracking services compared to the profits reported accord-
ing to GAAP. Moreover, earnings response coefficients and regression R 2’s are
both higher for pro forma profits than for GAAP profits (Bradshaw and Sloan,
2002, p. 65; Bhattacharya et al., 2003, p. 316). As regards the use of pro
forma information for forecasting purposes, Bhattacharya et al. (2003) regressed
the revision of analysts’ one-quarter-ahead earnings forecasts on forecast errors
based on different earnings metrics. Their results suggest that pro forma earnings
have significantly greater explanatory power than earnings according to GAAP
(ibid., p. 309), which suggests that analysts regard pro forma earnings to be
more informative than GAAP earnings.
However, the use of pro forma reporting also involves some risks connected with
management’s behaviour and the quality of financial reporting. In preparing the pro
forma income statement, the items that are excluded in the GAAP counterpart are
referred to as ‘unusual items’, ‘non-core business items’, ‘non-cash items’, etc.
The managers’ official argument for this procedure is that it helps external stake-
holders to compare the underlying earnings capacity across companies. However,
the common anecdotal story is that managers seek to manipulate the external stake-
holders’ view of the company by excluding such items. As pro forma reporting is
highly dependent on management’s opinion of what is classified as ‘unusual’ or
‘non-core’, there is a substantial risk that the pro forma reporting will be
Does Pro Forma Reporting Bias Analyst Forecasts? 281
report GAAP earnings only in one version and both pro forma and GAAP earnings
in the other. Apart from different levels of annual percentage increase (8.8% as
against 0.8%), the pro forma earnings were slightly higher than the GAAP earnings
($1.68 as against $1.24 per share). The case was mailed to the analysts, but was
given to the students in small groups. On a basis of evidence from psychological
research on decision-making and expertise, Frederickson and Miller (2004) hypoth-
esized that non-professionals would predict higher stock prices when using
announcements including both pro forma and GAAP earnings than they would
do if the announcements only included GAAP earnings. As regards the financial
analysts, Frederickson and Miller formulated an explorative research question
instead of a formal hypothesis about the effect of pro forma reporting on analysts’
judgments, since earlier research had generated mixed evidence regarding the ten-
dency for accounting experts to be the victim of cognitive bias (e.g. Shanteau, 1989;
Smith and Kida, 1991; Maines, 1995). Frederickson and Miller (2004) found, in line
with their hypothesis, that the 22 MBA students who were exposed to pro forma
plus GAAP earnings announcements made higher stock price appraisals than did
the 24 students who received GAAP information only. However, this effect
could be explained by differences in the valuation models applied and by uninten-
tional cognitive effects, rather than by the non-professionals relying on pro forma
earnings information because they perceived it as being informative. Regarding
the explorative research question, it was found that the appraised stock prices
given by the participating analysts were similar regardless of the experimental
conditions. In other words, the analysts were not influenced by the presence of
pro forma reporting. Frederickson and Miller (2004) suggested that this finding
was due to the tendency on the part of the participating analysts to rely on
well-defined valuation models.
Elliott (2006) casts further light on the effects of pro forma reporting, investi-
gating two issues: (1) whether it is the presence of pro forma information or the
particular emphasis of such information that affects non-professionals; and (2)
the extent to which the judgment of analysts and non-professionals is affected
when there is a quantitative reconciliation between the GAAP and pro forma
earnings calculations. On a basis of behavioural research showing that salient
information tends to capture people’s attention regardless of its usefulness,
Elliott hypothesized that non-professionals would arrive at a different judgment
when the emphasis was on pro forma earnings. She also predicted that a specifi-
cation of the pro forma adjustments (the reconciliation) would reduce the effect
of pro forma reporting on the judgment of non-professionals, whereas it would
not affect the judgment of analysts. To test these hypotheses Elliott conducted
an experiment involving 89 MBA students (representing non-professional inves-
tors) and 55 experienced analysts. The participants read a press release regarding
a hypothetical company in the technology sector. The release consisted of finan-
cial information for the first quarter of the last two years. The participants were
asked to rate the company’s earnings performance (on a 100 points scale ranging
from very weak to very strong) and then to decide on the amount of money to
Does Pro Forma Reporting Bias Analyst Forecasts? 283
invest in the company (ranging from $0 to $5,000). The press release was
manipulated as regards the presence of pro forma information, the emphasis on
pro forma information and the presence of a reconciliation of the differences
between the GAAP and the pro forma measures. The GAAP earnings were nega-
tive and the pro forma earnings slightly positive, respectively (i.e. a loss of $1.02
as against a profit of $0.01 per share). Elliott found that non-professionals tended
to rate earnings performance higher and to invest more money when they were
exposed to the press release emphasizing pro forma earnings. This tendency
was weaker when the same group read the press release that included a reconci-
liation. The analysts revealed no significant difference in judgment between the
press release emphasizing pro forma earnings and the other that included GAAP
information only. However, contrary to her hypothesis, Elliott (2006) reported
that analysts who had examined a press release involving a reconciliation gave
higher ratings to earnings performance and were willing to invest more money
in the company concerned than the analysts who were confronted by press
releases giving GAAP information only or those putting more emphasis on pro
forma earnings than on GAAP earnings. In her view, this somewhat paradoxical
finding could be explained by the tendency of the analysts to regard pro forma
earnings as more reliable and less misleading when reconciliation was present.
In sum, earlier studies provide consistent empirical evidence that pro forma
reporting does not seem to have any effect on analysts’ judgments, while the
judgments of non-professional investors may be so affected.4 However, the evi-
dence should be considered in light of the following factors which, in our view,
limit its validity and reliability. First, Frederickson and Miller (2004) rely on a
case in which pro forma earnings do not differ substantially from GAAP earnings.
The difference per share was $0.44, corresponding to about 1.7% of the mean
stock price appreciation made by the analysts. Bigger discrepancies could have
consequences for the analysts’ judgments. Elliott’s (2006) case material included
a somewhat bigger difference ($1.03 per share), but then there was also a ten-
dency towards higher analyst rankings for earnings performance in the GAAP
press release compared to the case of the pro forma earnings press release.5
Further, neither Frederickson and Miller (2004) nor Elliott (2006) analysed the
case of pro forma profits and GAAP losses in pro forma reports,6 although
such combinations are not uncommon in practice, according to the results of
studies of pro forma reporting based on archival data:
. . . the mean GAAP earnings is a net loss of 14.7 cents per share, while the
mean pro forma earnings is a net income of 8.5 cents per share. This result
is consistent with the notion expressed in the popular press that most items
excluded from GAAP income to arrive at the pro forma number are
expenses that decrease income. Moreover, it is consistent with the results
of prior academic research examining actual pro forma press releases . . .
the possibility that some audit decisions were associated with anchoring and
adjustment. It should be noted that auditors’ tasks differ from those of financial
analysts, which suggests that tendencies observed in one profession may not
necessarily apply to another. Further, there is a body of research showing that
expert judgment is fragile, even in the case of accustomed tasks (e.g. Camerer
and Johnson, 1991; Andersson, 2005; Tetlock, 2005). For example, despite con-
siderable experience, managers tend to be the victims of anchoring effects
(Lovallo and Kahneman, 2003). Anchoring has also been claimed to partly
explain overreactions and underreactions in analysts’ earnings forecasts (Amir
and Ganzach, 1998). Moreover, length of experience is also weakly related to
performance (Ericsson and Lehmann, 1996). Thus, even if financial analysts
are regarded as experts, they may still be sensitive to framing and anchoring
effects.
Despite the conflicting evidence as to whether or not experts are victims of
judgmental heuristics, previous studies (Frederickson and Miller, 2004; Elliott,
2006) have argued that analysts will not be influenced by pro forma information,
due to their expertise. Elliott (2006) for example found that analysts were not
affected by the emphasis on pro forma earnings and attributed this to their invest-
ment-related expertise and familiarity with the task. However, one manipulation
in Elliott’s experiments with her analyst subjects (the manipulation involving a
quantitative reconciliation between pro forma and GAAP information), yields
statistically significant results that are inconsistent with her hypothesis, thus
casting some doubt on the expertise argument that is used to support both of
the hypotheses related to analysts. Elliott attributed this inconsistency to a
greater perceived reliability regarding pro forma earnings as compared to
GAAP, when reconciliation is added. An alternative interpretation could be
that this manipulation stimulated framing and anchoring effects.8
Thus, we dispute the expertise argument and argue that the impact of pro forma
earnings is related primarily to the psychological theory of anchoring. In testing
this theory, the anchors used should not be too similar, in other words there needs
to be a marked difference between pro forma earnings and GAAP. One real-
world example of this could concern firms that are reporting pro forma earnings
at the same time as GAAP losses. Such firms also tend to give greater emphasis to
pro forma earnings in their press releases, compared with other companies
(Bowen et al., 2005, p. 1013), which motivates an emphasis on pro forma earn-
ings in the case design. In light of the above, the following hypothesis was
formulated.
H1: Earnings releases including both pro forma and GAAP-based infor-
mation will be associated with forecasts of higher EPS than earnings
releases that include GAAP-based information only.
As well as testing this hypothesis, we also look at whether pro forma reporting
affects the amount of confidence that financial analysts place in their forecasts,
288 P. Andersson & N. Hellman
an issue that has not been explored in previous studies. Intuitively, one would
expect that the conflicting information in earnings releases based on pro forma
and GAAP statements would inspire less confidence than earnings releases
based on GAAP alone. On the one hand, research shows that access to additional
information makes people more confident, even though the additional infor-
mation does not necessarily lead to more accurate predictions (Oskamp, 1982).
On the other hand, judgment research in financial accounting suggests that the
effect of providing professionals with additional information can be mixed (cf.
Maines, 1995). In view of these rather imprecise findings, we decided to
include a research question about the effects of pro forma reporting on confi-
dence, rather than formulating a hypothesis on the issue. For this reason, we
will also look into the level of confidence associated with earnings releases
including both pro forma and GAAP-based information and compare this with
the level of confidence associated with earnings releases including GAAP infor-
mation only.
4. Methodology
4.1. Rationale for the Chosen Experimental Approach
To test our hypothesis (H1), we decided to adopt an experimental approach. This
scientific method, which is commonly used in (Anglo-American) accounting
research (cf. Libby et al., 2002), enables a reliable evaluation of causes and
effects in controlled environments. For the purpose of the present paper, such
an approach made it possible to observe analysts’ forecasting behaviour under
exposure to two types of earnings releases, namely, GAAP-based or pro forma
information. Further, given the experimental approach, it was possible to
ensure that all analysts had equal access to the information (except in so far as
it was manipulated for experimental purposes) and to control for any contami-
nating factors. For instance, if analysts had responded on different occasions,
the possibility cannot be ruled out that their judgment might have been affected
by the vagaries of the daily (business) news. Similarly, incentives arising from
institutional circumstances also tend to distort analysts’ forecasts (e.g. Hunton
and McEwen, 1997). Another factor, which hampers the findings presented in
Frederickson and Miller (2004) and Elliott (2006), could be that the analysts
may employ a variety of decision aids or, may simply hand over the task to
someone not fully qualified to deliver responses on their behalf.
Further, the experimental approach has advantages lacking in other research
methods such as interviews or the econometric analysis of archival data, as it
allows for the separate examination of effects associated with the financial report-
ing. First, in real-life listed companies do not publish two separate earnings
releases that are sent to two groups of analysts. Second, in making their earnings
forecasts many analysts tend to take note of their colleagues’ estimates, so that
their own estimates do not deviate too far from these (Trueman, 1994). Third,
Does Pro Forma Reporting Bias Analyst Forecasts? 289
some analysts may possess private information enabling them to make more
reliable earnings forecasts.
4.2. Participants
Thirty-six financial analysts (29 of them males) who had enrolled in an executive
education programme in advanced finance were asked to make their own evalu-
ation of an earnings release. Their mean age was 34.8 years. The main occupation
of around 81% of them concerned corporate analyses and stock investment, while
the rest of them were engaged in stockbroking and giving financial advice. Their
average experience of the tasks concerned was 6.1 years.
Table 1. Summary of the contents of the study material: GAAP and pro forma earnings
releases
GAAP earnings release Pro forma earnings release
Note: The two earnings releases were written in Swedish and all amounts in the two reports were given
in Swedish kronor (SEK). On 18 February 2007, 100 SEK corresponded to about $14.22 or E10.82.
predict EPS guarantees greater external validity, since it avoids some of the pro-
blems associated with other approaches (see Sections 2.3 and 2.4). Second, after
noting their responses, the participants indicated their level of confidence on a 6-
point scale ranging from ‘very unsure’ to ‘very sure’. There were then seven
empty lines where the participants could comment on their predictions.
Largely, the purpose of these lines was to check the extent to which the subjects
had observed and interpreted the content of the independent variable (cf. Libby
et al., 2002). Third, the participants were asked to evaluate the degree of
realism in the material and whether the information given was sufficient as a
basis for economic forecasting. These questions represented an attempt to
measure the external validity of the study material. Finally, there were questions
about demographics, the motivation for participating in the study and the time
devoted to the experiment.10
Does Pro Forma Reporting Bias Analyst Forecasts? 291
Before running the experiment, the study material was pre-tested on four Ph.D.
students specializing in accounting and financial analysis. On the whole, they felt
that the instructions were clear and that the contents of the study material were
realistic.
4.5. Procedure
The two types of earnings release were randomly distributed among the partici-
pants at a lecture on advanced finance. The participants were instructed to make
an individual examination of the study material, and then to answer a question-
naire. As an incentive they were each given the reward of their choice: one
cinema ticket or three lottery tickets worth approximately $10 (64% chose the
lottery tickets), if their completed questionnaire were drawn.
A total of 16 participants read the GAAP report, while 20 studied the pro forma
report. The majority of the participants (61%) said that they felt motivated to
undertake the task. On average, it took about 19 minutes to complete the task
and to answer the questionnaire. Despite exposure to different parts of the
material, the two groups did not differ significantly when it came to the (self-
reported) time devoted to the task.
5. Results
For the participant groups as a whole the average EPS forecast was 25.83 SEK
(SD ¼ 12.96). Table 2 shows clearly that the two types of earnings releases
yielded substantially different EPS forecasts. Participants examining the GAAP
report predicted a lower EPS (M ¼ 213.13 SEK) than those who were given
the combined report of pro forma and GAAP-based information (M ¼ 0.00
SEK). Note that the forecasts submitted by this second participant group were
more widely dispersed and covered a greater range (40) than those made by
Table 2. Descriptive statistics regarding EPS forecasts and the confidence in such forecasts
Type of earnings release
GAAP Pro forma
information and GAAP information
(n ¼ 16) (n ¼ 20)
Note: The EPS forecast was measured on an 11-point scale ranging from ‘ 2 50 SEK’ (1) to ‘50 SEK’
(11), while confidence was rated on a 6-point scale ranging from ‘very unsure’ to ‘very sure’.
292 P. Andersson & N. Hellman
experience and the seven with more experience who all received the GAAP
report predicted more or less the same level of EPS (M ¼ 212.22 as against
214.29). Similarly, there was no substantial difference between the predictions
of the 12 less experienced and the 8 more experienced participants who were
given the report combining both pro forma and GAAP-based information
(M ¼ 23.33 as against 5.00). The application of non-parametric tests (i.e.
Mann – Whitney U), which was motivated by the limited numbers in the two
length-of-experience subgroups revealed non-significant differences only.11
In order to make a simultaneous evaluation of the effects of the experimental
manipulation (GAAP as against pro forma) and level of experience (less vs.
more), a multiple regression model was tested with EPS forecast as the dependent
variable (MS ¼ 8.24, F(2) ¼ 6.43, p , 0.001). The model had a significant pre-
dictor, which was the experimental manipulation (standardized beta ¼ 0.52,
t ¼ 3.49, p , 0.001) and a non-significant predictor, which was the level of
experience (standardized beta ¼ 0.14, t ¼ 0.95, n.s.). Accounting for about
24% of the variance concerning the EPS forecasts, the regression model gave
further support for the hypothesis.
Finally, after they had made their forecasts, the participants were asked to
comment on the study material. Of those who received the GAAP report, one par-
ticipant considered the material to be unrealistic, while the equivalent figure for
the pro forma group was five. Eight in the former group and 11 in the latter con-
sidered the material to be realistic. The rest of the participants said they were
doubtful about the realism of the study material. At the same time, many partici-
pants (50 and 65%, respectively) wanted additional information and found the
material as it stood to be insufficient for economic forecasting. Overall, the per-
ceived lack of unrealism and the demand for additional information seem reason-
able, given the need for simplification in experimental settings. Nevertheless, the
response to the debriefing questions did not suggest that the study material was
perceived as incorrect or misleading. Moreover, statistical tests (i.e. t-tests,
Mann – Whitney U) showed that the responses to the debriefing questions were
unrelated to the EPS forecasts.
Earlier research on analysts’ forecast revisions indicates that analysts find pro
forma earnings to be significantly more informative, providing a more stable
measure of future profitability than GAAP earnings (Bhattacharya et al., 2003,
p. 310). However, if pro forma numbers draw attention away from GAAP in a
way that affects users’ judgments, this may have adverse effects for some user
groups. Earlier studies have reported that the judgments of non-sophisticated
users tend to be affected by pro forma reporting, whereas sophisticated users’
judgments remain unaffected (Frederickson and Miller, 2004; Elliott, 2006;
Allee et al., 2007). In contrast, our results show that sophisticated users will
also be affected when there is a substantial difference between GAAP earnings
and pro forma earnings. This should make standard setters concerned. Analysts
have a legitimate demand for financial statements that constitute a good basis
for forecasting. However, the increasingly complex financial statements pro-
duced under IFRS and US GAAP have been unable to satisfy this demand and
therefore analysts seek more forecasting-relevant, pro forma accounting infor-
mation. This observation implies a questioning of the standards as such.
Further, our study shows that such alternative (non-GAAP) measures may bias
analysts’ judgment. If pro forma accounting becomes the dominant source of
information for analysts, they may gradually lose their trust in accounting,
since earlier research indicates that pro forma accounting numbers are not com-
parable across companies and not consistently reported over time (Doyle et al.,
2003; Bhattacharya et al., 2004).
We believe that there is room for more experimental research on pro forma
reporting. The results reported in Elliott (2006) regarding the role of quantitative
reconciliation between pro forma and GAAP needs to be examined further.
In view of the results of the present paper, it would be interesting to include
reconciliation in a setting where the discrepancy between pro forma and
GAAP earnings is substantial, involving a pro forma profit and a GAAP loss.
In addition, the results reported in Bhattacharya et al. (2004), namely, that pro
forma reporting appears to be manipulated by companies to meet analysts’ expec-
tations, hold interesting possibilities for future experimental research.
Acknowledgements
Both authors contributed equally to this work, the order of authorship is arbitrary.
Helpful and valuable comments from Salvador Carmona and two anonymous
reviewers are gratefully acknowledged. The first author wishes to thank the
research foundation of Jan Wallander and Tom Hedelius for financial support.
Notes
1
Ordinary net profit, calculated according to Generally Accepted Accounting Principles
(GAAP), is adjusted for items that are in some sense ‘unusual’. This could include restructuring
charges, write-downs and impairments, research and development expenses, merger and
296 P. Andersson & N. Hellman
acquisition costs, stock compensation expense, goodwill amortization, etc. (Bradshaw and
Sloan, 2002).
2
Bradshaw and Sloan (2002) reported this empirical result on the basis of a comparison between
GAAP earnings and pro forma earnings as registered by analyst tracking services. Thus, they do
not use the companies’ pro forma earnings measures. However, the analyst tracking services
base their pro forma measures on companies’ specifications of what is referred to as non-
recurring or non-cash expenses.
3
Quotations from the speech are included in Bhattacharya et al. (2003, pp. 286–288).
4
These results reported in Frederickson and Miller (2004) and Elliott (2006) also agree with
those of a recent study based on archival data by Allee et al. (2007).
5
According to the descriptive statistics in Elliott (2006), analysts who received the press release
emphasizing pro forma earnings gave slightly higher earnings performance ratings than ana-
lysts who received GAAP information only (31.94 compared to 28.82 on the 100-point
scale). The pro forma earnings press release with reconciliation caused analysts to give signifi-
cantly higher earnings performance rankings compared to the press release including GAAP
information only.
6
Elliott (2006) reports a case in which the GAAP loss of $1.02 is transformed into a pro forma
profit close to zero ($0.01).
7
Analysts’ stock price appraisals could be expected to be preceded by analyst forecasts of a par-
ticular valuation attribute, such as earnings. Furthermore, the appraisal will involve subjective
risk considerations. In the case of investment decisions, analysts do not typically make such
decisions. The analysts’ earnings performance ranking (Elliott, 2006) is likely to be the depen-
dent variable that comes closest to the analyst’s primary real-world task of making earnings
forecasts.
8
In a study based on archival data, Doyle et al. (2003, p. 159) reported that some of the items
excluded from pro forma reports (denoted ‘special items’) are unrelated to future cash flows
from operations, whereas other excluded items (denoted ‘other exclusions’) have a pronounced
negative relation with future cash flows from operations. It is possible that analysts use the
reconciliation to learn more about the type of items affecting the pro forma reporting. If
there are a lot of ‘special items’, this might be a reason for viewing the company more posi-
tively than if the items were part of the group of ‘other exclusions’.
9
The complete research instrument can be obtained from the corresponding author.
10
There were also additional questions prompting the participants to make subjective probability
forecasts with respect to the likelihood of higher sales, lower costs, improved income or a stron-
ger financial position, as well as indicating their confidence in the forecasts concerned.
11
As suggested by one of our reviewers, an alternative procedure would involve splitting the
sample into three subgroups so that the participating analysts were categorized as limited, mod-
erately or highly experienced (n ¼ 19, 13, 16). Such a procedure was also adopted. A Kruskal–
Wallis test showed that the subgroups did not show significantly different reactions to the types
of financial report. Nor were the differences between the limited and highly experienced ana-
lysts significant.
12
We thank an anonymous referee for suggesting this design.
13
We thank an anonymous reviewer for helpful comments on the implications of our results for
standard setters.
References
Allee, M. J., Bhattacharya, N., Black, E. L. and Christensen, T. E. (2007) Pro forma disclosure and
investor sophistication: external validation of experimental evidence using archival data,
Accounting, Organizations and Society, 32(3), pp. 201 –222.
Amir, E. and Ganzach, Y. (1998) Overreaction and underreaction in analysts’ forecasts, Journal of
Economic Behavior & Organization, 37(3), pp. 333–347.
Does Pro Forma Reporting Bias Analyst Forecasts? 297
Andersson, P. (2005) How well do financial experts perform? A review of empirical research on per-
formance of analysts, day-traders, forecasters, fund managers, investors, and stockbrokers, The
ICFAI Journal of Behavioral Finance, 2, pp. 44 –61.
Ayton, P. (1998) How bad is human judgment?, in: G. Wright and P. Goodwin (Eds) Forecasting with
Judgment, pp. 237–267 (Chichester: Wiley).
Bhattacharya, N., Black, E. L., Christensen, T. E. and Larson, C. R. (2003) Assessing the relative
informativeness and permanence of pro forma earnings and GAAP operating earnings,
Journal of Accounting and Economics, 36(1–3), pp. 285 –319.
Bhattacharya, N., Black, E. L., Christensen, T. E. and Mergenthaler, R. D. (2004) Empirical evidence
on recent trends in pro forma reporting, Accounting Horizons, 18(1), pp. 27 –43.
Bouwman, M. J., Frishkoff, P. A. and Frishkoff, P. (1987) How do financial analysts make decisions?
A process model of the investment screening decision, Accounting, Organizations and Society,
12(1), pp. 1 –29.
Bowen, R. M., Davis, A. K. and Matsumoto, D. K. (2005) Emphasis on pro forma versus GAAP earn-
ings in quarterly press releases: determinants, SEC intervention, and market reactions, The
Accounting Review, 80(4), pp. 1011–1038.
Bradshaw, M. T. and Sloan, R. G. (2002) GAAP versus the Street: an empirical assessment of two
alternative definitions of earnings, Journal of Accounting Research, 40(1), pp. 41 –66.
Camerer, C. F. (2000) Prospect theory in the wild, in: D. Kahneman and A. Tversky (Eds) Choices,
Values, and Frames, pp. 288–300 (New York: Cambridge University Press).
Camerer, C. F. and Johnson, E. J. (1991) The process–performance paradox in expert judgment: how
can experts know so much and predict so badly?, in: K. A. Ericsson and J. Smith (Eds) Toward a
General Theory of Expertise: Prospects and Limits, pp. 195–217 (New York: Cambridge
University Press).
Chapman, G. B. and Johnson, E. J. (2002) Incorporating the irrelevant: anchors in judgments of
belief and value, in: T. Gilovich, D. Griffin and D. Kahneman (Eds) Heuristics and
Biases: The Psychology of Intuitive Judgment, pp. 120–138 (New York: Cambridge University
Press).
Doyle, J. T., Lundholm, R. J. and Soliman, M. T. (2003) The predictive value of expenses excluded
from pro forma earnings, Review of Accounting Studies, 8(2/3), pp. 145–174.
Elliott, W. B. (2006) Are investors influenced by pro forma emphasis and reconciliations in earnings
announcements?, The Accounting Review, 81(1), pp. 113 –133.
Ericsson, K. A. and Lehmann, A. C. (1996) Expert and exceptional performance: evidence of maximal
adaptation to task constraints, Annual Review of Psychology, 47, pp. 273 –305.
Ernst & Young (2006) IFRS: Observations on the Implementation of IFRS. Available
at: http://www.ey.com/Global/download.nsf/International/IFRS_Implementation_of_IFRS_
Master/$file/EY_IFRS_ImplementationOfIFRS_Master.pdf
Financial Accounting Standards Board (FASB) (2002) Reporting Information about the Financial
Performance Reporting by Business Enterprises: Focusing on the Form and Content of Financial
Statements. Available at: http://www.fasb.org/proposals/performance.pdf
Frederickson, J. R. and Miller, J. S. (2004) The effects of pro forma earnings disclosures on analysts’
and nonprofessional investors’ equity valuation judgments, The Accounting Review, 79(3),
pp. 667–686.
Hunton, J. E. and McEwen, R. A. (1997) An assessment of the relation between analysts’ earnings
forecast accuracy, motivational incentives and cognitive information search strategy, The
Accounting Review, 72(4), pp. 497 –515.
Johnson, W. B. and Schwartz, W. C. (2001) Are investors misled by pro forma earnings?, Working
Paper, University of Iowa. Available at: www.ssrn.com
Kahneman, D. and Tversky, A. (1979) Prospect theory: an analysis of decision under risk, Econome-
trica, 47(2), pp. 263 –291.
Kahneman, D. and Tversky, A. (1984) Choices, values and frames, American Psychologist, 39,
pp. 341–50.
298 P. Andersson & N. Hellman
Libby, R., Bloomfield, R. and Nelson, M. W. (2002) Experimental research in financial accounting,
Accounting, Organizations and Society, 27(8), pp. 775 –810.
Lovallo, D. and Kahneman, D. (2003) Delusion of success – how optimism undermines executives’
decisions, Harvard Business Review, 81(7), pp. 56–63.
Maines, L. A. (1995) Judgment and decision-making research in financial accounting: a review and
analysis, in: R. H. Ashton and A. H. Ashton (Eds) Judgment and Decision-Making in Accounting
and Auditing, pp. 76–101 (New York: Cambridge University Press).
Olbert, L. (1994) Stock valuation methods of financial analysts in a thin stock market in Sweden, with
comparisons to the United Kingdom and the United States, International Journal of Accounting,
29(2), pp. 123 –135.
Oskamp, S. (1982) Overconfidence in case-study judgments, in: D. Kahneman, P. Slovic and
A. Tversky (Eds) Judgment under Uncertainty: Heuristics and Biases, pp. 287–293
(New York: Cambridge University Press).
Pitt, H. (2001) Remarks before the AICPA governing council, Miami Beach, FL, 22 October.
Securities and Exchange Commission (SEC) (2003) Final Rule: Conditions for Non-GAAP Financial
Measures, Release No. 33– 8176, 34– 47226, FR–65.
Shanteau, J. (1989) Cognitive heuristics and biases in behavioral auditing: review, comments and
observations, Accounting, Organizations and Society, 14(1/2), pp. 165–177.
Smith, J. and Kida, T. (1991) Heuristics and biases: expertise and task realism in auditing, Psychologi-
cal Bulletin, 109(3), pp. 472–489.
Soman, D. (2004) Framing, loss aversion, and mental accounting, in: D. J. Koehler and N. Harvey
(Eds) Blackwell Handbook of Judgment and Decision Making, pp. 379 –398 (Oxford:
Blackwell).
Stockholmsbörsen (2003) Börsregler 2003/2004 – Handledning till noteringsavtal och noteringskrav
[Stock Exchange Rules 2003/2004 – Manual to the Listing Contract and Listing Requirements],
Stockholmsbörsens skriftserie No. 2.
Tetlock, P. E. (2005) Expert Political Judgment: How Good Is It? How Can We Know? (Princeton,
NJ: Princeton University Press).
Trueman, B. (1994) Analysts’ forecasts and herding behavior, Review of Financial Studies, 7(1),
pp. 97 –124.
Tversky, A. and Kahneman, D. (1974) Judgment under uncertainty: heuristics and biases, Science,
185, pp. 1124–1131.
Tversky, A. and Kahneman, D. (1981) The framing of decision and the psychology of choice, Science,
211, pp. 453–458.
Whyte, G. and Sebenius, J. K. (1997) The effect of multiple anchors on anchoring in individual and
group judgment, Organizational Behavior and Human Decision Processes, 69(1), pp. 75– 85.