Income Classification Shifting and Financial Analysts' Earnings Forecasts

• In Event: SESSION 4D: Forecasts and Earnings

Abstract

Income classification shifting involves opportunistically misclassifying core expenses into nonrecurring items in order to boost core earnings. Recent studies have documented large sample evidence of its existence (e.g.McVay, 2006;Fan et al.,2010; Barua et al.,2010). This study examines whether financial analysts can identify income classification shifting behavior in reported earnings and incorporate it into their future earnings forecasts. I find that analysts revise their future earnings forecasts to a lesser degree for firms engaged in classification shifting in the current period, suggesting that analysts recognize that income classification shifters’ core earnings are less likely to persist into the future. However, I also find that analysts fail to fully assess the extent of the impact of classification shifting on future earnings, leading to more optimistically biased forecasts for classification shifters. Finally, classification shifting makes it more difficult for analysts to forecast earnings, resulting in lower forecast accuracy for classification shifters.

Author

• Shanshan Pan, Louisiana State University - Baton Rouge