Do aggressive pro forma earnings-reporting firms have difficulty disclosing intellectual capital? Australian evidence
| Pages | 875-896 |
| DOI | https://doi.org/10.1108/JIC-03-2017-0051 |
| Published date | 26 June 2018 |
| Date | 26 June 2018 |
| Author | Yiru Yang |
| Subject Matter | Organizational structure/dynamics,HR & organizational behaviour,Accounting/accountancy,Knowledge management,Accounting & Finance |
Do aggressive pro forma
earnings-reporting firms have
difficulty disclosing intellectual
capital? Australian evidence
Yiru Yang
School of Accounting Economics and Finance, University of Wollongong,
Wollongong, Australia
Abstract
Purpose –The purpose of this paper is to investigate whether aggressive pro forma earnings-reporting firms
are difficult in relation to signalling sufficient intellectual capital (IC), and howthe market reacts to aggressive
pro forma earnings reporting.
Design/methodology/approach –Content analysis of 610 annual reports of Australian firms listed on the
Australian Securities Exchange 200 is used to obtain IC information. Fixed-effects logistic and ordinary least
squares (OLS) regressions are used to examine the hypotheses.
Findings –The study finds that aggressive pro forma earnings reporting is negatively and significantly
associated with sufficient IC disclosure. Moreover, this paper finds that investors react favourably to
aggressive pro forma earnings reporting, and believe that pro forma earnings have greater incremental
value-relevance information than statutory earnings.
Research limitations/implications –The coding framework used in this study comprises 33 IC items.
Other studies have used coding frameworks comprising fewer or more varied IC items. Therefore, when
comparing the results of this and other studies, the interpretation of the findings must recognise the
differences in approach.
Practical implications –Sufficient IC disclosure may help investors to distinguish high-reporting-quality
firms and low-reporting-quality firms. The paper demonstrates that aggressive pro forma earnings-reporting
firms, which are low-reporting-quality firms, are less likely to disclose sufficient IC.
Originality/value –This paper is the first to examine the relationship between aggressive pro forma
reporting and IC disclosure. Moreover, this paper built a theoretical framework based on signalling theory to
develop research hypotheses, which extend the research on IC underpinned by signalling theory.
Keywords Intellectual capital disclosure, Market reaction, Aggressive pro forma earnings
Paper type Research paper
1. Introduction
The rise of the “new economy”, which is driven by information and knowledge, has led to an
increased interest in intellectual capital (IC) in recent decades. In this new-economy age, only
firms that account for their IC can positively influence the investment decisions and the
value of firms (Holland, 2003; Bukh et al., 2005; Bukh, 2003; Joshi et al., 2013). Firms that do
not disclose IC generate information asymmetries and a lack of transparency, so this
deficiency in IC reporting means that financial reporting partially loses its relevance
(Barth et al., 2001; Vafaei et al., 2011). Therefore, allowing for sufficient IC disclosure would
enhance the value relevance of accounting numbers to investors (Lev and Zarowin, 1999;
Barth and Clinch, 1996).
Based on signalling theory, this paper assumes that firms with a high level of IC are more
likely to disclose IC because it represents an inimitable and non-replaceable resource that
enhances firm performance and stock price, whereas firms with a low level of IC often find it
difficult to disclose sufficient IC because it is difficult to imitate. As a market-valuation
incentive, firms with a low level of IC are more likely to practice aggressive pro forma
earnings reporting to influence investors’perceptions of the firm’s performance[1].
Therefore, this paper attempts to examine whether aggressive pro forma earnings-reporting
Journal of Intellectual Capital
Vol. 19 No. 5, 2018
pp. 875-896
© Emerald PublishingLimited
1469-1930
DOI 10.1108/JIC-03-2017-0051
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1469-1930.htm
875
Intellectual
capital
firms are difficult in relation to signalling sufficient IC, and how the investors react to
aggressive pro forma earnings reporting.
The sample used for this study is based on 610 observations of Australian firms listed on
the Australian Securities Exchange (ASX) 200 from year 2009 to year 2012. The research
finds evidence that aggressive pro forma earnings reporting is negatively related to
sufficient IC disclosure. In addition, it is found that when firms report pro forma earnings
aggressively, the market reacts favourably to those pro forma earnings figures, and believes
that pro forma earnings are more value relevant than statutory earnings. Collectively, the
results of this paper suggest that low-reporting-quality firms are less likely to disclose
sufficient IC, and use aggressive pro forma earnings reporting to influence market
perceptions of firm performance.
This paper makes several contributions to the existing literature on IC disclosure and
earnings management. First, prior studies have found that firms that make sufficient IC
disclosure havehigh earnings quality and therefore arguethat IC is important in relation to a
firm’s growthand success (see Darabi etal., 2012; Mojtahedi, 2013), but no studyhas examined
whether aggressive pro forma earnings-reporting firms are less likely to disclose IC. The
current studyis the first to examine the relationshipbetween aggressive pro formadisclosure
and IC disclosure,and suggests that firms withaggressive pro forma earnings disclosure find
it difficult to disclose sufficient IC because it is difficult to imitate and replace. Second,
Abeysekera(2006) observed that the developmentof a theoretical framework for IC disclosure
is in its infancy, with few studies providing a strong theoretical basis for interpreting their
findings;in fact, research on IC underpinnedby signalling theory is extremely limited (Li et al.,
2008). To addressthis gap in the research, this study buildsa theoretical framework basedon
signalling theory to develop research hypotheses and finds that aggressive pro forma
earnings-reporting firms are difficult in relation to signalling sufficient IC. Third, this paper
contributes to the literature on non-statutory-earnings management by providing evidence
that the market is misled by aggressive earnings reporting; and that sufficient IC disclosure
may help to distinguish low-quality-reporting firms andhigh-quality-reporting firmsbecause
aggressive non-statutory-earnings firms (i.e. low-quality-reporting firms) are less likely to
disclose sufficient IC.
The remainder of this paper is organised as follows. Section 2 provides a literature
review. Section 3 explains the theoretical framework and hypotheses development. Section 4
describes the research design of this paper. Section 5 presents the descriptive statistics,
Pearson and Spearman correlations and regressions results. Section 6 provides the
additional tests. Section 7 presents the conclusion.
2. Literature review
2.1 Pro forma earnings
Pro forma earnings are calculated based on the judgements of the preparer that reflect the
“core”or “recurring”business activities of reporting firms. It is voluntarily reported
non-statutory earnings based on standards other than the International Financial Reporting
Standards (IFRS) or in line with the IFRS and then adjusted by firm managers (Australian
Institute of Company Directors (AICD) and Financial Services Institute of Australasia
(FINSIA), 2009). Firms use labels to describe pro forma earnings, for example, “underlying
earnings”,“normalised earnings”,“pro forma earnings before interest and taxes (EBIT)”,
“pro forma earnings before interest, taxes, depreciation and amortisation (EBITDA)”,
“earnings before exceptional items”,“result excluding exceptional items”,“results before
non-recurring items”,“results before significant items”,“results before special items”,
“results before specific items”,“adjusted EBIT”,“adjusted EBITDA”,“adjusted operating
earnings”(Ernst & Young, 2007; AICD and FINSIA, 2009). The pro forma earnings
examined in this paper represent all such terms because they provide an alternative to
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