Earnings Management Constraints and Classification Shifting

27 Pages Posted: 26 Jul 2014

See all articles by John L. Abernathy

John L. Abernathy

Kennesaw State University

Brooke Beyer

Kansas State University

Eric T. Rapley

Colorado State University, Fort Collins - Department of Accounting

Date Written: June/July 2014

Abstract

Prior literature has investigated three forms of earnings management: real earnings management (REM), accruals earnings management (AEM) and classification shifting. Managers make trade‐off decisions among these methods based on the costs, constraints and timing of each strategy. This study investigates whether managers use classification shifting when their ability to use other forms of earnings management is constrained. We find that when REM is constrained by poor financial condition, high levels of institutional ownership and low industry market share, managers are more likely to use classification shifting. Further, we find that when AEM is constrained by low accounting system flexibility and the provision of a cash flow forecast, managers are more likely to use classification shifting. In addition, when we limit our sample to firms that are most likely to have manipulated earnings, we continue to find support for constraints of both REM and AEM leading to higher levels of classification shifting. We also find support for the hypothesis that the timing of each earnings management strategy influences managers’ trade‐off decision. Our results indicate that managers use classification shifting as substitute form of earnings management for both AEM and REM.

Keywords: earnings management, earnings management constraint, classification shifting

Suggested Citation

Abernathy, John L. and Beyer, Brooke and Rapley, Eric T., Earnings Management Constraints and Classification Shifting (June/July 2014). Journal of Business Finance & Accounting, Vol. 41, Issue 5-6, pp. 600-626, 2014. Available at SSRN: https://ssrn.com/abstract=2472223 or http://dx.doi.org/10.1111/jbfa.12076

John L. Abernathy (Contact Author)

Kennesaw State University ( email )

1000 Chastain Road
Kennesaw, GA 30144
United States

Brooke Beyer

Kansas State University ( email )

Manhattan, KS 66506
United States
7855325916 (Phone)

Eric T. Rapley

Colorado State University, Fort Collins - Department of Accounting ( email )

257 Rockwell Hall
Fort Collins, CO 80523
United States
970.491.7481 (Phone)

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