We show that firms with executive bonuses that qualify for deduction under Internal Revenue Code Section 162(m) were less likely to expense stock option compensation (SOC) in 2002. Additionally, the more likely it is that a qualified firm will incur re-contracting costs, the less likely it is that the firm will expense SOC. CEOs of qualified firms that also expense SOC receive smaller bonuses than CEOs of expensing firms that are not qualified under 162(m), and the lower 162(m) bonuses are not offset by higher SOC. Our results suggest that 162(m) tax incentives are an important determinant of the decision to expense SOC.

US GAAP requires most intangible investments to be expensed as incurred, potentially distorting performance measurement. We examine whether voluntary non-GAAP disclosures mitigate these distortions for intangible-intensive firms. We find that intangible-intensive firms are more likely to report non-GAAP performance metrics when GAAP earnings lack relevance and that the resulting exclusions are of higher quality. Challenging the prevailing view that high-quality exclusions are limited to transitory items, we demonstrate that non-GAAP disclosures can also enhance performance measurement by excluding investment expenditures. Consistent with this mechanism, we find that intangible-intensive firms are more likely to exclude investment-related expenditures, that their non-GAAP disclosures are associated with higher returns to intangible investments, and that removing R&D enhances the predictive relevance of the performance metric. These effects are unique to firms that expense, rather than capitalize, intangible assets, highlighting the role of non-GAAP reporting in mitigating distortions arising from the mandatory expensing of intangible investments.

We investigate whether income smoothing affects the usefulness of earnings for contracting through the monitoring role of earnings‐based debt covenants. First, we examine initial contract design and predict that income smoothing will increase (decrease) the use of earnings‐based covenants if income smoothing improves (reduces) the usefulness of earnings to monitor borrowers. We find that private debt contracts to borrowers with greater income smoothing are more likely to include earnings‐based covenants. A structural model that explores the cause of this relationship provides evidence that smoothing improves the ability of earnings to reflect credit risk. Second, we examine technical default following contract inception. We find that income smoothing is associated with a lower likelihood of spurious technical default (when the borrower's economic performance has not declined but the loan nevertheless enters technical default). In contrast, we find no association between income smoothing and performance technical default (when the borrower's economic performance has declined). Collectively, this evidence is consistent with income smoothing improving the effectiveness of earnings‐based information in monitoring borrowers.