Earnings Management Using Discontinued Operations

Abstract

This paper investigates whether managers use classification shifting to manage earnings when reporting discontinued operations. Using a methodology similar to McVay (2006), we find evidence consistent with our hypothesis that firms shift operating expenses to income-decreasing discontinued operations to increase core earnings. Our findings also indicate that managers use classification shifting to meet or beat analysts’ forecasts. Finally, we find that since the introduction of SFAS 144, the reporting frequency of discontinued operations has increased; however, the magnitude of classification shifting has decreased. We provide potential explanations for this finding.