Can 'Big Bath' and Earnings Smoothing Coexist as Equilibrium Financial Reporting Strategies?

Kirschenheiter, Michael; Melumad, Nahum D.

doi:10.2139/ssrn.300551

Cited by 57 publications

(28 citation statements)

References 10 publications

Supporting

Mentioning

Contrasting

Unclassified

Order By: Relevance

“…Earnings smoothing can also convey private information about future earnings and the permanent level of earnings (e.g., Beidleman ; Barnea, Ronen, and Sadan ; Ronen and Sadan ; Demski ; Kirschenheiter and Melumad ; Tucker and Zarowin ). Consistent with this view, Dichev and Tang () find smoother earnings streams are more persistent and predictive of earnings up to five years ahead.…”

Section: Related Literature and Hypothesis Developmentmentioning

confidence: 99%

Is Real Earnings Smoothing Harmful? Evidence from Firm‐Specific Stock Price Crash Risk

Khurana

Pereira

Zhang

2017

Contemporary Accting Res

121

115

View full text Add to dashboard Cite

This study examines whether and when real earnings smoothing influences firm‐specific stock price crash risk. Using a sample of U.S. public firms for the years 1993 through 2014, we find real earnings smoothing to be positively associated with firm‐specific stock price crash risk. This finding is consistent with the view that real earnings smoothing helps managers withhold bad news, keep poor‐performing projects, conceal resource diversion, and engage in ineffective risk management, which increases crash risk. Further, we find a stronger relation between crash risk and real earnings smoothing when firm uncertainty is higher, product market competition is lower, and balance sheet constraint is higher. Overall, our study suggests that real earnings smoothing destroys shareholder value in that it increases stock price crash risk.

show abstract

Section: Related Literature and Hypothesis Developmentmentioning

confidence: 99%

Is Real Earnings Smoothing Harmful? Evidence from Firm‐Specific Stock Price Crash Risk

Khurana

Pereira

Zhang

2017

Contemporary Accting Res

121

115

View full text Add to dashboard Cite

show abstract

“…I next exploit the analysis in Kirschenheiter and Melumad [2002] to investigate settings in which theory suggests that managerial discretion plays a role and, in particular, is informative. Specifically, I explore the relation between ACEV and informed trading during periods of extreme performance.…”

Section: Proactive Discretion Versus Neutral Application Of Accounmentioning

confidence: 99%

“…Third, I examine a situation in which theory suggests that proactive discretionary choices are likely to be informative. Exploiting the analysis of Kirschenheiter and Melumad [2002], in which big baths taken during periods of extremely poor performance and income smoothing during periods of extremely good performance perfectly reveal underlying cash flows, I investigate the relation between the accrual component and informed trading during periods of extreme performance. Consistent with their theory, I find that the relation between the magnitude of the accrual component and informed trading is attenuated during these periods, suggesting that proactive discretion does not always garble information and may in fact be informative when performance is extremely good or bad.…”

mentioning

confidence: 99%

Earnings Volatility, Cash Flow Volatility, and Informed Trading

Jayaraman

2008

J of Accounting Research

156

View full text Add to dashboard Cite

I examine whether earnings that are smoother or more volatile than cash flows provide or garble information. Consistent with theories that predict more informed trading when public information is less informative, I find that bid-ask spreads and the probability of informed trading are higher both when earnings are smoother than cash flows and also when earnings are more volatile than cash flows. Additional tests suggest that managers' discretionary choices that lead to smoother or more volatile earnings than cash flows garble information, on average. However, I find that informed trading is attenuated in settings in which theory suggests that discretionary smoothing or volatizing of earnings is likely to be informative.

show abstract

“…"Big bath accounting" is the use of earnings management to manipulate poor earnings downwards so they become even poorer. The idea behind it all is that in the subsequent years, the chance of showing higher returns increases (Kirschenheiter & Melumad, 2002). "Aggressive accounting" is the use of optimistic projections or gray areas in the accounting standards to create financial statements that present a rosier picture of a company than is actually the case.…”

Section: Hypothesis Developmentmentioning

confidence: 99%