Classification Shifting: Impact of Financial Distress

Abstract

We contribute to the literature on earnings management by the financially troubled firms, and present evidence that the managers of such firms are more likely to inflate core or operating income as compared to the healthy firms. They do so by misclassifying core or operating expenses as income-decreasing special items. Specifically, core expenses are shifted to income-decreasing special items like goodwill impairments, settlement costs, restructuring costs and write downs.