Date of Award

12-31-2022

Document Type

Campus Access Dissertation

Degree Name

Doctor of Philosophy (PhD)

Department

Business Administration

First Advisor

Robert Kim

Second Advisor

Atreya Chakraborty

Third Advisor

Sangwan Kim

Abstract

This dissertation is composed of three related essays that investigate the motivations of the managers engaging in classification shifting –– the shifting of core expenses such as COGS and SG&A downwards to one-time items such as special items to inflate core earnings. The first essay examines the effect of litigation risk on classification shifting. Using a quasi-natural experiment of Ninth Circuit Court ruling as a decreasing litigation risk event, I find that firms experiencing lower litigation risk are less likely to engage in opportunistic classification shifting. The results support the notion that when litigation risk as a governance mechanism is lower, managers resort more to accruals and real earnings management and less to classification shifting, i.e., substitution effect. The finding is more pronounced for the firms whose accruals and real earnings management are constrained and for the firms facing higher ex-ante litigation risk before the ruling. The second essay examines whether managers engage in classification shifting for credit rating considerations. Using the S&P long-term credit ratings, we find that firms in the broad categories of BBB and BB misclassify core expenses as special items to inflate core earnings. Firms facing financial constraints and those with high leverage are more likely to engage in classification shifting. Further, we show that managers rely on classification shifting when they perceive the costs of accrual-based and real activities earnings management to be significant. Governance mechanisms in the form of analyst following, institutional ownership, and audit quality have deterrent effects on the use of classification shifting by rated firms. Finally, firms near the investment–speculative borderline successfully receive a rating upgrade in the near future through classification shifting. The third essay examines the relationship between competition environment, specifically product market fluidity, and classification shifting. I find that firms with high product market fluidity are more likely to engage in classification shifting. The effect is non-linear, i.e., stronger for moderate product market fluidity as opposed to high or low levels of product market fluidity. In sum, the three essays highlight the interplay between managers’ reporting choices, their incentives and external environment, and contribute to various streams of literature on earnings management, securities class action litigation, credit rating, and product market competition.

Comments

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