Classification Shifting and Future Stock Price Crash Risk

Abstract

We examine whether classification shifting is associated with stock price crash risk. Unlike prior studies, our study is focused on bad news hoarding through classification shifting. Prior studies document evidence of the greater weight market participants place on core earnings and stock price crash resulting from delayed bad news releases. Building upon these findings, we predict that crash risk is positively associated with shifters’ reversal of core earnings. Consistent with our conjecture, we find that classification shifting is positively associated with future stock price crash risk even if the bottom‐line net income is unchanged. This finding is robust after controlling for endogeneity and other determinants of classification shifting. We also find that the observed positive association between classification shifting and future stock price crash risk is pronounced for likely opportunistic classification shifters. Our research contributes to forming an enhanced understanding of crash risk by documenting differential negative market reactions to the change in core earnings driven by classification shifting.