Major asset restructuring performance commitments and classification shifting through non-recurring items

Abstract

We examine whether firms engage in classification shifting to meet performance targets during mergers and restructuring. Using a sample of listed firms that complete major asset restructuring and sign performance commitment agreements from 2008 to 2019, we find that during the commitment period, nearly 39% of firms ‘step on the line’ to achieve net income before non-recurring items, i.e., the realised performance slightly exceeds the promised performance target. Compared to control firms and non-commitment years, firms that ‘step on the line’ to meet the target are more likely to achieve this by misclassifying recurring expenses as non-operating losses. Furthermore, this effect is more pronounced in firms with larger committed amounts, firms using stock to compensate for non-performance, and firms audited by non-Big 4 auditors. Overall, our paper extends the research on incentives for classification shifting and has implications for regulators to strengthen the regulation of accounting treatment in performance commitments.