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The Impact Of The Sarbanes-Oxley Act On Earnings Management Using Classification Shifting Evidence From Core Earnings And Special Items

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  • Xudong Li

Abstract

This paper examines whether the passage of the Sarbanes-Oxley Act (thereafter, SOX) curbs firms’ earnings management behavior through shifting core expenses to special items. The passage of SOX could be an effective deterrent to misclassification activities as it aims to prevent accounting fraud and limit management misbehavior, imposing significant legal liabilities and stiffer penalties on managers for aggressive financial reporting. Alternatively, because classification shifting does not affect reported net income, thereby is less likely to be detected and associated with lower litigation risk, it is likely to be used as a substitute for accruals-based earnings management and therefore experiences an increasing trend in the post-SOX period. Using a sample period from 1988 to 2010, I find evidence consistent with the deterrent effect, that is, the magnitude of unexpected core earnings declines and firms shift fewer core expenses to special items after the passage of the SOX of 2002. My study adds to the literature on the impact of SOX on earnings management by finding that SOX is effective in curbing classification shifting between core earnings and special items, a form of earnings management that misrepresents components of earnings but has no effect on the bottom line income

Suggested Citation

  • Xudong Li, 2016. "The Impact Of The Sarbanes-Oxley Act On Earnings Management Using Classification Shifting Evidence From Core Earnings And Special Items," Accounting & Taxation, The Institute for Business and Finance Research, vol. 8(1), pages 39-48.
  • Handle: RePEc:ibf:acttax:v:8:y:2016:i:1:p:39-48
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    References listed on IDEAS

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    1. Campello, Murillo & Graham, John R. & Harvey, Campbell R., 2010. "The real effects of financial constraints: Evidence from a financial crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 470-487, September.
    2. Jamal Ibrahim Haidar, 2012. "Sovereign Credit Risk in the Eurozone," World Economics, World Economics, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, vol. 13(1), pages 123-136, January.
    3. Kuo, Jing-Ming & Ning, Lutao & Song, Xiaoqi, 2014. "The Real and Accrual-based Earnings Management Behaviors: Evidence from the Split Share Structure Reform in China," The International Journal of Accounting, Elsevier, vol. 49(1), pages 101-136.
    4. Michael Clement & Richard Frankel & Jeffrey Miller, 2003. "Confirming Management Earnings Forecasts, Earnings Uncertainty, and Stock Returns," Journal of Accounting Research, Wiley Blackwell, vol. 41(4), pages 653-679, September.
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    More about this item

    Keywords

    Classification Shifting; Core Earnings; Special Items;

    JEL classification:

    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting

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