In a speech to the Annual Conference of European Accounting Association on Wednesday, Hans Hoogevorst said, not only is there a growing disconnect between actual and adjusted earnings numbers, which is worrying in light of the fact that companies tend to base management remuneration packages on these adjusted earnings.
“More than 88% of the S&P 500 currently disclose non-GAAP metrics in their earnings release. Of those releases, 82% show increased net income and are clearly designed to present results in a more favourable light,” Hoogevorst said.
According to one study, he added, so-called ‘core earnings’ were on average 30% higher than the Generally Accepted Accounting Practice earnings metric. While acknowledging that the numbers cited are for the American market, he added that securities regulators making use of international financial reporting standards are also concerned that “non-GAAP numbers are getting increasingly detached from reality”.
Hoogevorst admitted that the board of IFRS has to look at its own role in this issue and said there are a number of remedies that might be considered, including, among other things defining more subtotals within the income statement and providing more rigorous definitions of performance metrics above the bottom line
But, he added: “Knowing that even GAAP numbers can be vulnerable to earnings management, remuneration committees should be extremely wary to base their policies on earnings adjusted by management itself!”
Citing a recent example where a CEO’s remuneration was increased despite the company suffering a hefty loss as a result of his remuneration being based on non-GAAP measures “that almost completely insulated his income from factors that are considered to be outside the control of management”, Hoogevorst said:
“The irony of this case is that the company’s shareholders had previously approved the remuneration policy, apparently without anticipating what the consequences could be. Clearly, both shareholders and remuneration committees need to be much more aware and critical of the role of non-GAAP measures in remuneration formulas.”
