Income Classification Shifting and Financial Analysts’ Forecasts

Abstract

Income classification shifting involves misclassifying core expenses into non-core items to boost core earnings. Managers engage in classification shifting because they believe they can manage the perceptions of investors and financial analysts. We examine analysts’ earnings forecasts to determine whether analysts can identify classification shifting ex post and how they respond to shifted income statement components. Analysts play a role as information intermediaries between firms and investors. We find that analysts respond less to increased core earnings from classification shifting. However, analysts fail to gauge the full impact of classification shifting, leading to more optimistically biased and less accurate forecasts.