Earnings Management Constraints and Classification Shifting


  • John L. Abernathy,

    Corresponding author
    • Address for correspondence: John L. Abernathy, the Kennesaw State University, 1000 Chastain Road, Kennesaw, GA 30144, United States.

      e-mail: jabern21@kennesaw.edu

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    • The first author is at the Kennesaw State University, 1000 Chastain Road, Kennesaw, GA 30144, United States. The second author is at the Virginia Tech, 3007 Pamplin College of Business, 880 West Campus Drive, Blacksburg, VA 24061, United States. The third author is at the University of North Texas - Department of Accounting, 1155 Union Circle #305219, Denton, TX 76203-5017, United States. The authors gratefully acknowledge helpful comments from Weerapat Attachot, Michael Barnes, Jimmy Downes, Lauren Gorman, Binod Guragai, Sandeep Nabar, Mark Riley, Chad Stefaniak, Gary Taylor, Michael Wolfe, seminar participants at Oklahoma State University and an anonymous reviewer for the American Accounting Association Annual meeting. The authors are especially grateful to an anonymous referee, whose comments helped to significantly improve the paper, as well as to Martin Walker (Editor) for help with the paper.

  • Brooke Beyer,

  • Eric T. Rapley


Prior literature has investigated three forms of earnings management: real earnings management (REM), accruals earnings management (AEM) and classification shifting. Managers make trade-off decisions among these methods based on the costs, constraints and timing of each strategy. This study investigates whether managers use classification shifting when their ability to use other forms of earnings management is constrained. We find that when REM is constrained by poor financial condition, high levels of institutional ownership and low industry market share, managers are more likely to use classification shifting. Further, we find that when AEM is constrained by low accounting system flexibility and the provision of a cash flow forecast, managers are more likely to use classification shifting. In addition, when we limit our sample to firms that are most likely to have manipulated earnings, we continue to find support for constraints of both REM and AEM leading to higher levels of classification shifting. We also find support for the hypothesis that the timing of each earnings management strategy influences managers’ trade-off decision. Our results indicate that managers use classification shifting as substitute form of earnings management for both AEM and REM.