Are All Special Items Equally Special? The Predictive Role of Conservatism
48 Pages Posted: 18 Jul 2007 Last revised: 11 Jan 2009
Date Written: December 22, 2008
We predict the persistence of large negative special items based on expected accounting conservatism. Greater conservatism results in immediate recognition of anticipated future cash flow losses, leading to large negative special items that are highly associated with contemporaneous returns. If prompt loss recognition induces managers to terminate loss-producing projects earlier, then negative special items reported by more conservative firms should exhibit faster reversal. In contrast, if firms with lower expected conservatism enjoy greater flexibility in spreading the recognition of losses then they are apt to experience future losses associated with current special items, and consequently should exhibit lower reversal. We predict and find that negative special items of these firms are less closely tied to contemporaneous returns and are more persistent with respect to future net income. Additional analysis indicates that the variation in special-items persistence does not simply reflect variation in the persistence of all earnings components, nor is it restricted to firms that just meet or beat important earnings targets.
Keywords: asymmetric timeliness, differential timeliness, special items, special items persistence, earnings persistence, conservatism, strategic reporting, special items classification, CSCORE, predicted conservatism
JEL Classification: M41, M43, M44, G12
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