Industry Window Dressing

Abstract

We explore a new mechanism by which investors take correlated shortcuts, and present evidence that managers undertake actions – in the form of sales management – to take advantage of these shortcuts. Specifically, we exploit a regulatory provision wherein a firm’s primary industry is determined by the highest sales segment. Exploiting this regulation, we provide evidence that investors classify operationally nearly identical firms vastly differently depending on their placement around this sales cut-off. Moreover, managers appear to exploit this by manipulating sales to be just over the cutoff in favorable industries. Further evidence suggests that managers then engage in activities to realize large, tangible benefits from this opportunistic action.

Keywords: Industry window dressing, opportunistic management, discontinuity, favorable industries

JEL Classification: G02, G10, G32