Stewardship value of income statement classifications: an empirical examination

Abstract

A classified income statement has up to four distinct components of earnings - income from continuing operations, special items, discontinued operations, and extraordinary items. This study investigates how persistence and controllability affect the stewardship role of earnings components. The results correspond to our intuition regarding persistence and controllability of earnings components. Among above the line items, income from continuing items, the most persistent item, also receives the most weight, followed by special items which have smaller persistence. Among below the line items, discontinued items, which are at least under partial control of the CEO receive a positive weight while extraordinary items, which are largely beyond the control of the CEO, are filtered in compensation. Since special items make up the vast majority of nonrecurring items, we select them for further analysis. It appears that compensation committees modify the weight on special items based on their frequency and historical pattern. When we disaggregate special items by type we find that some items flow through to compensation while others are filtered. Combining disparate item into one, as has been done in prior literature may mask their true economic significance.