Study: CEOs Use Non-GAAP Earnings Metrics to Boost Pay

Chris Gaetano
Published Date:
Sep 18, 2017
'MIND THE GAP 5023794412' by Licensed under CC BY 2.0 via Wikimedia Commons

A recent study from MIT has found that when companies make large positive adjustments to non-GAAP earnings, their CEOs make 23 percent more than their expected annual compensation would be if GAAP numbers were used. This is despite such firms having weak contemporaneous and future operating performance relative to other firms, according to Financial Executives International

The researchers looked through the annual earnings press releases of S&P 500 firms for fiscal years 2010 through 2015 and recorded GAAP net income and non-GAAP net income when the firms disclosed it. About 67 percent of the firms in the sample disclose non-GAAP net income. For the other third, there was no deviation between GAAP and non-GAAP net income in earnings press release. The researchers then obtained CEO compensation, accounting, and return data for the sample firms. 

Doing this, they found that "firms making the largest positive non-GAAP adjustments... exhibit the worst GAAP performance." On average, non-GAAP adjustments more than double their GAAP earnings from less than 5 percent of total assets to non-GAAP earnings that are more than 10 percent, which indicates that managers exploit the latitude in making non-GAAP adjustments during periods of poor GAAP earnings performance. The CEOs of these firms, meanwhile, about 23 percent more than would be predicted using a compensation model; in terms of raw dollars, this means they make about $2.7 million more than the approximately $12 million that the average CEO makes. The researchers added the caveat that a few CEOs with large amounts of compensation throws off the averages, but, nonetheless, the firms with the highest non-GAAP adjustments still stand out with $1 million more in excess compensation than other groups. 

"The results in the prior section are consistent with our hypothesis that firms make positive adjustments to GAAP income to defend high CEO pay that would not be supported by the traditional economic determinants of executive compensation," said the study authors. 

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