Classification Shifting, Abnormal Earnings Dynamics, and Stock Valuation

58 Pages Posted: 13 May 2016

See all articles by Ahmed Abdalla

Ahmed Abdalla

London School of Economics

Colin Clubb

University of London - King's College London - Department of Management

Date Written: 2016

Abstract

We examine the information content of earnings components conditional on the existence of misclassification of earnings in the income statement. We develop a vector autoregression (VAR) of a set of accounting variables that accommodates, besides other variables, two components of transitory earnings; a core component reflecting shifted core earnings and a transitory component reflecting purified transitory earnings. Our model analysis derives two properties of shifted core earnings. Shifted core earnings forecast future abnormal earnings similar to reported core earnings, and shifted core earnings provide a "bad news" signal of management incompetence. Using special items as measure of a transitory line item that is potentially contaminated by shifted earnings, we provide empirical evidence in support of the former. We propose and find empirically that purified special items are transitory. Nevertheless, our evidence suggests that stock prices do not fully reflect the heterogeneity between the core and transitory components of special items, but rather overstate the entire amount of special items when shifting is suspected.

Keywords: Classification shifting, valuation, abnormal earnings dynamics, transitory earnings, special items, decomposition

JEL Classification: M40, M41, G10, G19, G30

Suggested Citation

Abdalla, Ahmed and Clubb, Colin, Classification Shifting, Abnormal Earnings Dynamics, and Stock Valuation (2016). Available at SSRN: https://ssrn.com/abstract=2778780 or http://dx.doi.org/10.2139/ssrn.2778780

Ahmed Abdalla (Contact Author)

London School of Economics ( email )

United Kingdom

Colin Clubb

University of London - King's College London - Department of Management ( email )

150 Stamford Street
London, SE1 9NN
United Kingdom

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