Corporate social responsibility and the quality of financial reporting: evidence on classification shifting

Purpose This paper aims to exa mine the relationship between sustainability and earnings management in the European countries. Specifically, the authors investigate the impact of corporate social responsibility (CSR) on classification shifting, which occurs when management intentionally misclassifies recurring expenses as nonrecurring to inflate perceptions of core earnings. Design/methodology/approach The authors empirically investigate a sample of 4,523 observations between 2010 and 2022. The CSR score is collected from the ASSET4 database, while the other data are obtained from Eikon Refinitiv database. Findings The findings provide evidence of a significant positive relationship between non-recurring expenses (NREC) and unexpected core earnings in both the first and second samples. This suggests that certain companies may have engaged in the practice of shifting recurring expenses to nonrecurring items, artificially inflating their core profits. In particular, the study focuses on examining the interaction between the ESG score and nonrecurring expenses. Interestingly, the authors discovered that the coefficient of this interaction is significantly negative. This implies that classification shifting is less prevalent among firms that demonstrate a commitment to social responsibility. Overall, the results indicate that socially responsible firms exhibit lower levels of classification shifting compared to firms that do not prioritize social responsibility. Originality/value To the best of the authors’ knowledge, this is the first study to examine the relationship between CSR and classification shifting in the European context. It expands the literature by identifying CSR commitment as a determinant of misclassification behavior across all earnings management strategies, including those most resistant to conventional audit. Unlike previous studies that focused on established moderators such as financial reporting incentives and corporate governance, this study further proposes a dual integrative framework in which agency theory and stakeholder theory function as complementary rather than competing perspectives, explicating the conditions under which CSR limits or facilitates earnings manipulation.