The Impact of the Sarbanes-Oxley Act on Earnings Management Using Classification Shifting: Evidence from Core Earnings and Special Items

Accounting & Taxation, v. 8 (1) p. 39-48

10 Pages Posted: 18 Feb 2017

See all articles by Xudong (Daniel) Li

Xudong (Daniel) Li

Monmouth University - Department of Accounting

Date Written: 2016

Abstract

This paper examines whether the passage of the Sarbanes-Oxley Act (thereafter, SOX) curbs firms’ earnings management behavior through shifting core expenses to special items. The passage of SOX could be an effective deterrent to misclassification activities as it aims to prevent accounting fraud and limit management misbehavior, imposing significant legal liabilities and stiffer penalties on managers for aggressive financial reporting. Alternatively, because classification shifting does not affect reported net income, thereby is less likely to be detected and associated with lower litigation risk, it is likely to be used as a substitute for accruals-based earnings management and therefore experiences an increasing trend in the post-SOX period. Using a sample period from 1988 to 2010, I find evidence consistent with the deterrent effect, that is, the magnitude of unexpected core earnings declines and firms shift fewer core expenses to special items after the passage of the SOX of 2002. My study adds to the literature on the impact of SOX on earnings management by finding that SOX is effective in curbing classification shifting between core earnings and special items, a form of earnings management that misrepresents components of earnings but has no effect on the bottom line income.

Keywords: SOX; Classification Shifting; Core Earnings; Special Items

JEL Classification: M4

Suggested Citation

Li, Xudong (Daniel), The Impact of the Sarbanes-Oxley Act on Earnings Management Using Classification Shifting: Evidence from Core Earnings and Special Items (2016). Accounting & Taxation, v. 8 (1) p. 39-48, Available at SSRN: https://ssrn.com/abstract=2909034

Xudong (Daniel) Li (Contact Author)

Monmouth University - Department of Accounting ( email )

West Long Branch, NJ 07764
United States

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