Prior research suggests that short sellers can monitor and limit opportunism in the reporting of conventional GAAP earnings. However, firms have increasingly begun to disclose customized earnings metrics calculated by excluding certain income items (usually expenses) to create their own non-GAAP version of earnings (which generally portrays a more optimistic view of performance). We extend this research by exploring how short sellers can influence the frequency and quality of non-GAAP earnings disclosures. Results from our difference-in-differences estimations indicate that short-selling pressure significantly mitigates aggressive non-GAAP earnings disclosures. Cross-sectional tests suggest that short sellers influence the quality of non-GAAP earnings through two channels: (a) the increased costs of misreporting and (b) direct monitoring. We perform a large set of robustness tests to rule out other possible explanations for our results. Given the SEC’s recent concern about non-GAAP reporting, our results have strong policy implications for the SEC’s current consideration of additional regulation of non-GAAP disclosure. Moreover, our evidence contributes both to the literature on earnings management and to ongoing policy debates on short sales constraints.
