Earnings Management by Classification Shifting and IPO Survival

The study examines the effect of earnings management by classification shifting on firm success, by focusing on the survival of newly listed firms. We argue that shifting income-decreasing expenses from core to special items should negatively associate with future operating performance because of improper signaling of actual repeatable core profitability. We find that classification shifting strongly and negatively affects future Initial Public Offering (IPO) success and survival. Our evidence indicates that this negative impact actually stems from adverse effects of non-transitory opportunistic special items, which constitute the tool for applying classification shifting, on future profits and operating cash flows, while our results are mitigated for IPO firms operating within stronger business contexts. Our findings provide evidence on the longer-term
effects of a method of earnings management that has long been considered “soft,” and without any longer-term reversing consequences.