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Abstract

Non-GAAP reporting is debated as managers might opportunistically exclude less justifiable, yet income increasing, items and mislead investors. In this paper, I investigate whether non-GAAP reporting improves or deteriorates after a firm admits to past GAAP based misreporting through a financial restatement announcement. Hirshleifer and Teoh (2003) propose that the managerial use of inappropriate non-GAAP adjustments increases in investors responsiveness to earnings and Mehring et al. (2020) show that investors responsiveness to aggressively reported non-GAAP earnings decreases after the restatement announcement. Consequently, conditional on managers awareness of reduced expected benefits from aggressive non-GAAP reporting choices, I predict and find a significant decline in the likelihood of aggressive non-GAAP reporting choices in form recurring expense exclusions. Moreover, in cross-sectional analyses, I document an improvement in non-GAAP exclusion quality for firms that have experienced severe short-term market reactions to the restatement announcement (material restatement firms), but not for those restatement firms that did not. Finally, I disaggregate total exclusions into below-the-line items, special items and recurring items. For material restatement firms, I find that the improvement in quality is found only in recurring expense exclusions; the type of exclusions perceived as most aggressive. In sum, my findings are consistent with the view that increased shareholder monitoring (heightened investor scrutiny) might constrain a firms aggressive use of non-GAAP disclosure. My findings are novel to the restatement and non-GAAP related literature and hold in the post-Regulation G period.