A Theory of Classification Shifting

Date
2017-09-01
Authors
Penno, Mark
Stecher, Jack
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Abstract
This article demonstrates that managers can influence the market by classifying some items as core earnings and others as non-core. Investors react to classifications because managers have incomplete discretion over how to classify results. Managers optimally use their discretion to pool good news with items mandatorily classified as core earnings and bad news with items mandatorily classified as non-core. Aggregation reduces this temptation to classify strategically, provided managers also have incomplete discretion over how to aggregate. That is, managers can use aggregation to separate from strategic classifiers. Our results provide empirical implications for the cross-sectional properties of financial reports.
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Keywords
Disclosure, Classification shifting, Aggregation, Simpson's paradox
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