Optimistic Reporting and Pessimistic Investing : Do Pro Forma Earnings Disclosures Attract Short Sellers?

We contribute to the debate regarding the informativeness of pro forma earnings disclosures by providing evidence that a group of informed traders, short sellers, trade as if firms' voluntary non-GAAP earnings disclosures create information advantages they can exploit. While prior research indicates that short sellers identify firms that will experience declining operating performance, we investigate whether the disclosure of pro forma earnings acts as an indicator of future price declines that is distinct from poor operating performance. We find that short selling is significantly higher in quarters in which firms disclose non-GAAP earnings metrics relative to quarters in which they do not disclose adjusted earnings measures. Moreover, we find that short selling is significantly positively associated with the exclusion of recurring items and, more particularly, with the exclusion of stock-based compensation. We also find some evidence that short sellers trade more when managers exclude expense items to appear to meet analysts' expectations on a pro forma basis when they fall short of expectations based on GAAP operating earnings. Finally, we find evidence based on abnormal returns suggesting that short sellers profit from short selling around earnings announcements containing pro forma earnings disclosures. Overall, the results are consistent with the notion that sophisticated market participants view pro forma earnings disclosures negatively and trade in order to take advantage of potential information asymmetries created by these disclosures