A Theory of Principles-Based Classification

Date
2020-08-18
Authors
Konvalinka, Matjaž
Penno, Mark
Stecher, Jack
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Abstract
We study a firm's decision to classify transactions as recurring or nonrecurring in a setting with no fixed classification scheme, but with the following principle: recurring transactions must be more persistent than nonrecurring ones. Under this principle, equilibrium firm behavior provides a new explanation for the observed relationship between income and classifications. Moreover, we find that market prices are more informative under principles-based classifications than they would be under a hypothetical, optimally chosen specific classification rule
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Keywords
Classification Shifting, Earnings Management, Principles, Rules, Signaling
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