Do CEO social connections promote corporate malpractices? Evidence from classification shifting

Abstract

This paper examines the effect of CEOs’ external social connections with other executives and directors on classification shifting, a widespread malpractice that inflates core earnings by altering the presentation of income statement line items without affecting bottom-line income. Using a sample of 995 UK listed firms in the period 2005 to 2016 and relying on the assumptions of social capital theory and the rent-extraction perspective, we find that CEOs with a larger number of external connections are more likely to engage in classification shifting. Further results indicate that this phenomenon occurs particularly when well-connected CEOs are local and/or are in the early years of their service. Collectively, the results suggest that social connections promote corporate malpractices that are unlikely to cause reputational losses. Overall, we contribute to the literature by providing evidence that the social capital of the CEO is an important driver of classification shifting.

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