The Effect of Classification Shifting on Firm Success
52 Pages Posted: 3 Dec 2019
Date Written: November 26, 2019
The study examines the effect of earnings management by classification shifting on firm success, by focusing on the survival of newly listed firms. We argue that shifting income-decreasing expenses from core to special items should negatively associate with future operating performance because of a) improper signaling of actual repeatable core profitability; and, more importantly b) in accordance with recent evidence by Cain, Kolev, and McVay (2019), suggesting a negative effect of opportunistic special items on future profits and cash flows. We find that classification shifting strongly and negatively affects future Initial Public Offering (IPO) success and survival. Our evidence indicates that this negative impact actually stems from adverse effects of non-transitory opportunistic special items, which constitute the tool for applying classification shifting, on future profits and operating cash flows, while our results are mitigated for IPO firms operating within stronger business contexts. Our findings provide evidence on the longer-term effects of a method of earnings management that has long been considered “soft,” and without any longer-term reversing consequences. Our evidence does not support this proposition in the case of newly listed IPO firms engaging in classification shifting around the time of issue.
Keywords: classification shifting; income manipulation; investor protection; initial public offering; ipo survival
JEL Classification: M41; M48; G14; G30; G32
Suggested Citation: Suggested Citation