Signaling Firm Performance Through Financial Statement Presentation: An Analysis Using Special Items
Executive Summary — Do managers' presentation decisions within their financial statements reflect informational motivations (that is, revealing the underlying economics of the firm) or opportunistic motivations (that is, attempts to bias perceptions of firm performance)? The authors examine managers' choices to present special items (such as write-offs and restructuring charges) separately on the income statement rather than aggregated in other line items with disclosure only in the footnotes. Prior research suggests that managers engage in opportunistic reporting in other presentation decisions, and that managers' presentation decisions on the financial statement affects users' judgments. The distinction also matters because current changes in reporting standards are likely to increase the occurrence of "nonrecurring" type charges similar to special items, such as fair value changes. Key concepts include:
- Managers, in most instances, appear to use the flexibility afforded in the presentation of special items to inform users of the underlying economics of these items.
- Special items receiving income statement presentation are more transitory than those receiving footnote presentation.
- These results are consistent with managers using discretion in the financial statement presentation of special items for informational reasons. There is limited evidence that opportunistic motivations underlie this presentation decision.
This paper investigates whether presentation of special items within the financial statements reflects the firm's underlying economic performance or opportunism. We examine the presentation of recognized special items either as a separate line item on the income statement or aggregated within another line item with disclosure only in the footnotes. Our study is motivated by standard-setting interest in performance reporting and financial statement presentation, as well as prior research investigating managers' presentation choices in other contexts. Using different constructs of persistence to capture the economics of reported special items, we find evidence consistent across a range of specifications that special items highlighted on the income statement are more transitory than those revealed only in the footnotes. For most special items, these results are consistent with this presentation decision reflecting underlying firm performance. For a subset observations—namely, those likely to reflect "big bath" reporting incentives—we provide limited evidence suggestive of opportunism in this presentation decision.