Review of Accounting Studies

, Volume 17, Issue 3, pp 526–562 | Cite as

Why do pro forma and Street earnings not reflect changes in GAAP? Evidence from SFAS 123R

  • Mary E. BarthEmail author
  • Ian D. Gow
  • Daniel J. Taylor


This study examines how key market participants—managers and analysts—responded to SFAS 123R’s controversial requirement that firms recognize stock-based compensation expense. Despite mandated recognition of the expense, some firms’ managers exclude it from pro forma earnings and some firms’ analysts exclude it from Street earnings. We find evidence consistent with managers opportunistically excluding the expense to increase earnings, smooth earnings, and meet earnings benchmarks but no evidence that these exclusions result in an earnings measure that better predicts future firm performance. In contrast, we find that analysts exclude the expense from earnings forecasts when exclusion increases earnings’ predictive ability for future performance and that opportunism generally does not explain exclusion by analysts incremental to exclusion by managers. Thus our findings indicate that opportunism is the primary explanation for exclusion of the expense from pro forma earnings and predictive ability is the primary explanation for exclusion from Street earnings. Our findings suggest the controversy surrounding the recognition of stock-based compensation expense may be attributable to cross-sectional variation in the relevance of the expense for equity valuation, as well as to differing incentives of market participants.


Stock-based compensation SFAS 123R Non-GAAP earnings Street earnings Pro forma earnings Earnings forecast exclusions Incentives 

JEL Classification

G10 M4 M41 M43 M45 



We thank David Aboody; Tom Lys; Robert Magee; Sarah McVay; Richard Sloan (editor); workshop participants at the 2011 Review of Accounting Studies conference, especially discussant Theodore Christensen; American Accounting Association annual meeting, especially discussant Valentina Zamora; the Financial Accounting and Reporting Section midyear meeting, especially discussant Melissa Lewis; the Kellogg School of Management; Lancaster University; Santa Clara University; Stanford University; University of Southern California; Yale University; and two anonymous reviewers for helpful comments and suggestions. We thank our respective schools for financial support.


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Copyright information

© Springer Science+Business Media, LLC 2012

Authors and Affiliations

  • Mary E. Barth
    • 1
    Email author
  • Ian D. Gow
    • 2
  • Daniel J. Taylor
    • 3
  1. 1.Graduate School of BusinessStanford UniversityStanfordUSA
  2. 2.Harvard Business SchoolBostonUSA
  3. 3.The Wharton SchoolUniversity of PennsylvaniaPhiladelphiaUSA

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