The order in a series of continuous special items and the likelihood of income classification shifting

Abstract

In income classification shifting, firms shift recurring income components (in core earnings) that are income reducing to items commonly assumed to be nonrecurring (special items) to increase core earnings, which are used by analysts and investors to forecast future earnings and value a firm. Some special items tend to extend over multiple quarters and are more amenable to classification shifting because it is easier to shift core expenses into those items (continuous special items). Nevertheless, as the recurrence of special items increases, the market perceives them more like recurring earnings components (Cready et al. in Account Rev 85(5):1577–1615, 2010), which reduces the benefits of classification shifting. Therefore, we hypothesize that when special items are continuous and first in a sequence of quarterly continuous special items, firms are more likely to use them to shift income than when continuous special items are last in the series. Our results confirm our expectations. The findings highlight that the location of a continuous special item in a sequence of continuous special items affects the likelihood of income classification shifting.