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Literature has documented management’s use of income classification shifting to increase core earnings. Specifically, core expenses, which include cost of goods sold and selling and administrative expenses, are shifted to non-core items to boost core earnings. However, there has been little research on whether firms at particular times reduce income increasing classification shifting or classification shift to reduce core earnings - classify non-core items as core expenses. Also, research on classification shifting under non-market incentives is limited. We fill these gaps by examining the classification shifting behavior of oil and gas firms in response to the BP oil spill. The BP oil spill was an unexpected event that led to adverse publicity and new or potential regulations and restrictions for oil and gas firms. This could have encouraged oil and gas firms to suppress core earnings following the oil spill. We adopt a difference-in-difference design which compares the shifting behavior between oil and gas firms and other firms before and after the BP oil spill. We provide evidence that after the BP oil spill, (1) the probability of oil and gas firms classification shifting to inflate core earnings declines relative to other firms and (2) the propensity for oil and gas companies to shift to report lower core earnings increases relative to other firms, such that oil and gas firms are more likely to engage in core earnings reducing classification shifting following the BP oil spill.
Steve Garner, Tennessee Tech University
Michael J Lacina, University of Houston-Clear Lake
Shanshan Pan, University of Houston-Clear Lake