Earnings Aggregation and Classification Shifting

This study documents the earnings subtotal that is the most value relevant and is perceived as core earnings by investors in Taiwan. I would then examine whether the firm manipulates core earnings by misclassifying losses (gains) items from the above to the below of the earnings subtotals. According to previous studies and the analysts report about earnings measures, I predict that continuing operating income before tax and special items (PRESI) has the highest explanatory value for share return. My results are consistent with my hypothesis and showing operating income before tax and special items (PRESI) is valued as core earnings in Taiwan. Following McVay (2006), I posit that managers tend to inflate operating income before tax and special items (PRESI) by shifting the expenses to special items and increasing both operating income before tax and special items (PRESI) and negative special items. The results in my study provide evidence that firms strategically use special items to increase their operating income before tax and special items (PRESI). I also find unexpected operating income before tax and special items reverses the subsequent year after a firm reports special items, indicating the use of special items to increase operating income before tax and special items (PRESI) is a one-time event. The results are consistent after controlling for firm characteristics.