I investigate changes in non-GAAP reporting following financial restatements—firms’ revelations of past GAAP reporting failures. As managers may feel more constrained in GAAP than in non-GAAP earnings management after financial restatements, they may increase their use of inappropriate non-GAAP adjustments, leading to a deterioration in non-GAAP reporting (substitution effect).
Contrary to this substitution effect, I find that the i) likelihood of recurring expense exclusions decreases and that the ii) quality of recurring expenses increases after material restatements, suggesting a post-restatement improvement in non-GAAP reporting. My findings are consistent with managers’ desire to regain investor trust and rebuild reputation (signaling view). Alternatively, this improvement could be attributed to managers’ assumption that heightened investor scrutiny after material restatements improves investors’ ability to distinguish between informative and inappropriate non-GAAP adjustments (expected payoff effect). My results support the view that investor scrutiny over GAAP reporting is one determinant of firms’ non-GAAP reporting choices.