Detecting Opportunistic Special Items

Abstract

The frequency of special items has increased dramatically over time, offering a convenient conduit for the inappropriate classification of past, present, and future recurring expenses as non-recurring. Identifying this misclassification is especially important in light of the pervasive use of non-GAAP earnings in recent periods, as special items offer camouflage for excluded recurring expenses. Building on prior research, we propose a method for identifying the predicted level of special items, attributing any excess to opportunism, and demonstrate the importance of this partitioning for financial statement users. In particular, we provide evidence that the opportunistic portion of special items is associated with lower future earnings, cash flows, and returns. We conclude that this portion of special items is more likely to contain opportunistically misclassified recurring expenses that should have been recognized as such in prior, current, or future periods. Thus, we provide a meaningful partition of special items that should be useful to investors, analysts, creditors, auditors, and regulators, as each of these parties must assess the implications of special items.

Keywords: Special items, transitory items, earnings quality, earnings management, future operating cash flows, restatements

JEL Classification: M41, M43