AAA Spark Meeting of Regions

Classification Shifting as Ethical Earnings Management

• In Event: Ethical Earnings Mangement, Earnings Report and Information Quality

Abstract

Classification shifting refers to the shifting of core expenses to special items to inflate core earnings. Prior literature provides mixed evidence on the motivation for classification shifting. Our results suggest that ethical firms view classification shifting as an acceptable method for earnings management. Specifically, we show that managers of firms with a strong ethical orientation, measured by CSR performance, do not constrain the use of classification shifting. On the contrary, a firm’s demonstrated commitment to ethical behavior is negatively associated with the use of other forms of earnings management (e.g., accrual earnings management) consistent with prior literature. Building on the ethical perception of classification shifting, we find that strong corporate governance generally constrains classification shifting for firms with a weak ethical orientation but does not reduce classification shifting for firms with a strong ethical orientation. In addition, when the importance of ethical considerations is reduced in favor of opportunistic considerations, firms reduce the use of classification shifting in favor of other forms of earnings management. Overall, our results suggest that firms make trade-off decisions based on the perceived ethicality of earnings management methods, with classification shifting being perceived as the least unethical.

Authors

• Curtis Farnsel, University of Dayton

• Kelly Ha, University of Oklahoma