The Persistence and Valuation Effects of Classification Shifting

40 Pages Posted: 31 May 2019 Last revised: 3 Nov 2020

Date Written: November 2, 2020

Abstract

Classification shifting is defined in the literature as managers’ intentional classification of certain core expenses as income-decreasing special items with the intent to inflate reported core performance. We develop and validate a new measure of firms’ propensity to engage in this reporting strategy, documenting that a firm’s use of classification shifting is persistent over time and relates to its use by peer firms. We also find that the cross-sectional variation in firms’ use of classification shifting is increasing in more recent years and that this strategy is associated with higher future firm valuation and stock returns. As one possible channel through which this valuation effect orginates, we hypothesize and find evidence consistent with classification shifting allowing firms to increase their debt capacity, thereby shifting risks from shareholders to debtholders.

Keywords: Classification shifting; special items; peer effects; persistence; valuation. .

JEL Classification: M4, M40, M41

Suggested Citation

Lattanzio, Gabriele and Thomas, Wayne B., The Persistence and Valuation Effects of Classification Shifting (November 2, 2020). Available at SSRN: https://ssrn.com/abstract=3384962 or http://dx.doi.org/10.2139/ssrn.3384962

Gabriele Lattanzio (Contact Author)

Monash University ( email )

Melbourne
Australia

HOME PAGE: http://www.gabrielelattanzio.com

Wayne B. Thomas

University of Oklahoma ( email )

Michael F. Price College of Business,
307 W Brooks, Rm 212B
Norman, OK 73019
United States
405-325-5789 (Phone)
405-325-7348 (Fax)

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