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Street earnings are used by analysts to track and forecast firm performance. Alongside these earnings are special items such as restructuring charges, profits or losses on asset sales, or asset write-downs or write-offs. When combined, they provide an opportunity for managers to frame their earnings, which has longer-term impacts on stock returns, according to research by Charles Hsu and William Kross.

Special items are non-operating earnings components that usually appear as separate line items in the income statement, but some managers include them as part of street earnings. They may have different motivations for doing this - either to signal the permanence of the special items or to frame earnings so as to influence the perception of these earnings - and the true motivation becomes evident in long-term stock returns.

"If managers are signaling the permanence of special items by their inclusion/exclusion from street earnings, there should be no relationship between stock returns and special items in the year subsequent to the earnings announcement," the authors said.

"If on the other hand managers are framing - portraying street earnings in the most positive light - then the announcement period returns should be more positively related to special items included in street earnings than those excluded, and stock returns in the year following the announcement should be more negatively related as overpricing of the included special items becomes evident and is corrected."

They find evidence of the latter in their examination of more than 230,000 firm-quarter observations from 1988-2006. Some 26,554 of these contained material special items, of which 20 per cent were included in street earnings. This was much higher than predicted in earlier studies that said special items would be excluded from street earnings at least 97 per cent of the time.

Special items were found to have a negative relationship to future earnings regardless of whether they were included in street earnings, but they were more likely to be included if they increased street earnings, smoothed earnings or allowed managers to meet earnings benchmarks.

"This result, coupled with negative persistence, implies managers include or exclude special items in an opportunistic manner - to mask lower income and smooth earnings - rather than to signal differential permanence," the authors said.

When the special items were included in street earnings, they were more likely to lead to overpricing by the market. This led to a later correction and thus a negative relationship between inclusion of special items and future returns. On the other hand, excluding special items led to appropriate pricing because investors recognized their transitory nature.

"These findings are consistent with investors not fully understanding that managers opportunistically frame earnings through inclusion or exclusion of special items in reported street earnings," the authors said.

They added that the results have potential implications for regulating opportunistic inclusion or exclusion of earnings components in street earnings.