Classification shifting to “hide” gains

Conventional wisdom is that managers shift recurring expenses downwards into non-recurring losses (expense shifting) to inflate core earnings. McVay (2006) and subsequent researchers document that expense shifting is prevalent in a setting characterized by non-recurring losses that receive less attention from investors. We identify a setting where firms are more likely to engage in shifting gains upwards to sales revenues (gain shifting). We use Chinese data because non-recurring items are mainly positive and bottom-line earnings are the official profitability benchmark for new equity offerings. We find that, when regulators exclude non-recurring gains from adjusted bottom-line earnings, firms are motivated to “hide” part of non-recurring gains within sales revenues to avoid the impact of the exclusion and the resulting reduction in bottom-line earnings.