Big Bath Research Articles

Storing Power: How Managers Use Big Bath Accounting to Convert between Different Sources of Power

Storing Power: How Managers Use Big Bath Accounting to Convert between Different Sources of Power

Characteristics of creative accounting: A Multifaceted Literature Analysis

Creative accounting has become a widespread practice in financial reporting. It involves manipulating financial data to paint a more positive picture of a company's financial performance or position. This paper aims to provide a comprehensive exploration of creative accounting. It will delve into its underlying factors, characteristics, different forms, and associated Implications. By reviewing existing literature, we will examine the complex relationship between creative accounting and factors such as ethics, quality of disclosure, internal control, and ownership structure. The discussion will shed light on the double-edged nature of creative accounting, acknowledging its potential for innovation in accounting practices while also recognizing its negative consequences for stakeholders when used unethically. Various forms of creative accounting, including earnings management, income smoothing, and big bath accounting, will be examined in detail, with a focus on their impact on financial reporting transparency and stakeholder perceptions. Additionally, this paper will discuss the precautions associated with creative accounting, emphasizing the need for careful consideration in financial decision-making and the importance of

A study of big bath practices in the Egyptian capital market: an emphasis on CEO turnover and origin

Purpose This study aims to investigate how major big bath accounting practices and CEO turnover in Egypt relate to one another, as well as the first to use the CEO’s origin as a moderating factor. Design/methodology/approach This study uses 10-year longitudinal data from 2012 to 2021 and 290 firm-year observations from Egypt’s listed nonfinancial firms that witnessed CEO turnover to identify the significant big bath accounting practices in Egyptian businesses after the Egyptian revolution and the COVID-19 pandemic. Using fixed and random effect models, the authors investigate the impact of CEO turnover on company earnings during the first year of a newly appointed CEO as an indicator of big bath practices after controlling CEO gender, experience, firm size, leverage, return on assets, return on equity and industry. The hypotheses were investigated using static panel data. Findings The results show the presence of big bath practices in the Egyptian market. Furthermore, big bath accounting practices are positively correlated with CEO turnover. Moreover, the results indicate that big bath accounting practices are only endured when external CEOs are employed, rather than internal ones. Research limitations/implications The sample size and availability of data are the main research limitations. In addition, this study only examined CEO turnover and CEO origin as moderators in big bath accounting. Thus, future research may consider other CEO characteristics and political factors associated with big bath practices. Practical implications The findings from this study offer valuable insights to investors and regulators for effective decision-making and governance practices within the Egyptian capital market, while also contributing to a more informed approach to emerging markets on a global scale. Originality/value The findings contribute to the big-bath and CEO turnover and origin literature by showing a lower ceiling for earnings manipulation and using Egypt as a case study due to its unique institutional environment.

A Path Analysis of Goodwill Impairment – Does Corporate Governance Matter?

Abstract Objective This paper examines the extent to which different corporate governance mechanisms affect the recognition and measurement of goodwill impairment, considering that these decisions are affected by a complex set of factors such as variables associated with corporate governance, economic/financial variables, and the market. Methodology We used data from 110 companies, both Spanish (75) and Portuguese (35), with listed securities, in the period 2010–2016 (unbalanced panel), and the path analysis method to infer financial and non-financial data relationships. Findings The results support the hypothesis that attributes linked to management and internal and external control mechanisms, as well as economic/financial, market and location variables, are directly and indirectly associated with the recognition of goodwill impairment. Value Added This paper outlines a company behavioral profile where opportunity seems to prevail over timely recognition and measurement of goodwill impairment. Big bath practices appear to be well founded, as well as the alignment of this strategy with market signals. Recommendations To foster the adoption of accounting practices close to the interests of all stakeholders, regulators should be encouraged to incentivize corporate governance models that promote the periodic rotation of the chief executive officer/chairman, the independence of all members of the statutory audit board, and training in economic and financial areas.

Earnings management risk and audit pricing: Evidence from big bath accounting

AbstractWe examine whether big baths (large and non‐recurring charges) affect auditors’ risk assessments and therefore result in higher audit fees. Prior studies have found that there is an asymmetric reaction from auditors on firms’ income‐increasing/decreasing accruals. We argue that auditors’ response to big baths is distinguishable from other types of earnings management as big baths provide incremental information to auditors beyond other earnings manipulation indicators. Our findings show that audit fees are significantly higher for firms with big baths, compared to other firms. We also present evidence that the positive relation between big baths and audit fees is stronger for firms with weaker corporate governance and greater information asymmetry. Overall, our results suggest that auditors expand their audit effort to mitigate the greater audit risk attributable to big baths, which in turn lead to higher audit fees.

The effect of natural disasters on big bath earnings management of banks: evidence from the 2005 US hurricane season

We investigate the effect of the 2005 US hurricane strikes on big bath earnings management in the banking industry. Using a difference-in-differences approach, we find that banks affected by the hurricanes add more discretionary loan loss provisions (DLLP) after the shock relative to unaffected banks. Further tests suggest that the hurricane-induced DLLP increase is attributable to opportunistic big bath accounting rather than to a precautionary motive. We also show that the effect of the hurricanes on big bath earnings management is more pronounced in banks that were managing earnings upwards more aggressively before the hurricanes.

Accrual-Based Earnings Management and the COVID-19 Pandemic

In this study, we document the accrual-based earnings management of Old Economy firms and New Economy firms (firms in the technology industry) and loss-making firms (firms with negative earnings in the pre-pandemic year, 2019) and profit firms in each economy, respectively, before, during, and in the recovery year of the COVID-19 pandemic. Using both univariate and difference-in-difference regression analyses, we find that old and new economy firms adopt different accrual-based earnings management, and Old Economy Loss firms changed their accrual-based earnings management the most during and in the recovery of the pandemic. During the 2020 pandemic, Old Economy Loss reported the lowest amount of accrual-based discretionary accruals. This suggests that Old Economy Loss firms are engaged in the most conservative approach to reporting their earnings, consistent with the big bath proposition. In the recovery year of the pandemic, 2021, we find that accrual-based earnings management reversed, with the old economy losing firms reporting the highest amounts of discretionary accruals. However, we do not find that the explanatory power of earnings on the variance of stock prices for the old economy loss firms is affected by their discretionary change in accounting accruals.

Changes in accounting estimates during the COVID-19 pandemic in the USA

PurposeThe authors investigate how managers adapt their financial reporting and disclosure practices in response to the COVID-19 pandemic through changes in accounting estimates (CAEs).Design/methodology/approachThe authors define the pandemic period as starting on March 1, 2020. The sample consists of 9,575 CAEs disclosed in quarterly (10-Qs) and annual (10-Ks) financial reports by US firms between January 1, 2004 and May 31, 2022. The authors perform multivariate analyses of the impact of the COVID-19 pandemic on the incidence of CAEs and on whether the impact of CAEs on firms' financial performance and reporting quality changes during the pandemic.FindingsIn the examination of the CAE footnote disclosures in the quarterly (10-Qs) and annual (10-Ks) reports of US companies, the authors find no evidence that the incidence of CAEs in 10-Ks or the number of firms reporting CAEs are significantly different in the pre-pandemic and pandemic periods, but the incidence of CAEs in 10-Qs is significantly higher in the pandemic period than in the pre-pandemic period. The authors also find that the number of CAEs related to revenue recognition increase significantly in the pandemic period, but CAEs in other categories decrease, with the sharpest drop seen in the liabilities category. Further investigation suggests that although the dollar impact of 10-K CAEs on current financial statements is higher during the pandemic period, firms with CAEs, especially positive CAEs, in either 10-Ks or 10-Qs are less likely to use CAEs to boost earnings in the pandemic period. However, the authors find evidence that firms tend to use CAEs to “big bath” current earnings and create reserve for future period. The authors have not observed any significant differences in how the various phases of the pandemic affect the reporting of CAEs. Additionally, there is no evidence to suggest that financially distressed firms report more or fewer CAEs during the pandemic.Practical implicationsThe results are consistent with the notion that, during the pandemic, firms exercise greater caution in their CAE disclosures, refraining from using CAEs as a means of boosting earnings but as a strategy to create reserve for future period. The paper highlights the challenges that various stakeholders face when assessing a company's current and future financial performance based on management's accounting estimates.Originality/valueThis study captures the impact of the COVID-19 pandemic on the incidence of CAEs and CAEs' impact on the financial performance and financial reporting quality of firms during the pandemic.

Do firms manage earnings after a downgrade in their credit rating?

PurposeThis paper aims to examine whether firms engage in earnings management immediately after experiencing a downgrade in their credit rating.Design/methodology/approachThis paper uses fixed-effects regression models to examine real- and accrual-based earnings management after firms experience a downgrade in their credit rating.FindingsInconsistent with prior studies where firms are reported to opportunistically increase their earnings prior to a credit rating event, this paper finds that firms use income-decreasing earnings management after their ratings are downgraded. This paper also finds that firms downgraded to below the investment grade rating not only significantly reduce both abnormal cash flows and discretionary accruals but also report larger asset impairments, suggesting that these firms exploit the rating downgrade to employ a big bath accounting.Practical implicationsThe results of this paper have practical implications for investors fixating on firm earnings after a credit rating downgrade, for shareholders of downgraded firms and regulators such as credit rating agencies.Originality/valueThe findings of this study contribute to the thin literature on earnings management after changes in credit rating by shedding lights on earnings management after a rating downgrade and complement the literature on the accounting choice of financially distressed firms. The empirical evidence documented in this study suggests that the occurrence of income-decreasing earnings management is not limited to only after a sovereign country rating downgrade as documented in a prior study but also occurs after a rating downgrade not associated with this event.

Management’s Discretionary Assessments of Goodwill Impairments—Evidence from STOXX Europe 600

The main issues of accounting reporting regarding goodwill are whether a firm’s management reliably conveys their private information about future earnings, and whether they disclose value-relevant and useful information to accounting users. In the current International Financial Reporting Standards (IFRS) regulations, the goodwill impairment test is based on management’s discretionary assessments. This study examines how goodwill impairment is reported under IFRS considering company- and industry-specific economic factors, proxies for earnings management, and macroeconomic crisis years. We extend previous research using tobit and logit regressions by employing a fixed-effects model. This approach is possible because of a panel dataset comprising 449 of 600 active companies sampled from the STOXX Europe 600 index from 2005 to 2018. We find that goodwill impairments are largely concentrated in certain companies, industries, and years. The regression models show a significant negative correlation between companies’ return on total assets and goodwill impairments. Moreover, we discover that goodwill impairments have a significant positive correlation with goodwill intensity, debt ratio, and the proxy for reporting a one-off big bath charge. In addition, we find that the global financial crisis in 2008–2009 and the European debt crisis in 2011 differ significantly from other fiscal years.

An Empirical Analysis of Corporate Governance and Earnings Management Motives Influencing Goodwill Impairment in Chinese Manufacturing Firms

Goodwill impairment, resulting from the impairment tests conducted on goodwill generated during business mergers, serves as an effective indicator of a company's true and reliable goodwill value, as well as its operational and financial conditions. This study investigates the impact of earnings management motivations on goodwill impairment from the perspective of corporate governance, focusing on Chinese manufacturing listed companies between 2016 and 2020. Utilizing regression analysis and panel data models, the study examines the internal governance mechanisms, including the combined shareholding ratio of the top ten shareholders, and the external governance mechanisms, such as the role of the four major auditing firms. The findings reveal that both "big bath" and earnings smoothing motives can influence companies' decisions to recognize goodwill impairment, while effective internal and external governance mechanisms can help mitigate earnings management motivations. Further analysis shows that non-state-owned manufacturing listed companies are more likely to exhibit goodwill impairment behaviors driven by earnings management motives. These findings provide valuable insights for listed companies seeking to improve their corporate governance structures and for Chinese capital market regulators aiming to enhance relevant regulatory policies and refine goodwill measurement standards.

The right time for a big bath: asset impairment recognition in earnings management

PurposeThe article investigates the patterns of asset impairment recognition in search of signs of “big bath” earnings management practices across an internationally diversified sample of public companies. It also elucidates the incentives that may underlie such practices and explores possible safeguards embedded in the existing corporate governance mechanisms.Design/methodology/approachThe article applied static panel and binary logit models to an international firm-level panel dataset of 1045 public companies observed between 2003 and 2018.FindingsOur empirical results suggest that recognition of asset impairment has no determinate impact on earnings volatility. Investigating the possibility of “big bath” earnings management practices, the authors found no impact of asset impairment recognition on total senior executive compensation in firms, which pay performance-based remuneration. The quality of corporate governance has appeared to impact the firms’ intertemporal proclivity to recognize asset impairment with those having the more entrenched and management-controlled boards being more likely to time impairment recognition by delaying it during exceptionally good and exceptionally bad years. While generally unlikely, recognition of asset impairment in a period with a recorded negative operating performance is found to be closely associated with key executive departures.Originality/valueThe article corroborates the salient role of corporate governance mechanisms in shaping the intertemporal patterns of asset impairment recognition. The possible remedies to the phenomenon should be derived therefrom.

Using Available‐for‐sale Securities to Smooth Earnings: Evidence from China

Utilizing a large sample of non‐financial public firms in China from 2009 to 2016, we find robust evidence that non‐financial firms smooth their earnings through realized gains and losses on available‐for‐sale (AFS) securities. This effect is more pronounced for firms with weaker internal and external corporate governance. Firms with an incentive to manipulate up their earnings are also less likely to smooth earnings through AFS securities. Moreover, firms with more accrual earnings management or real earnings management tend to smooth earnings to a greater extent through AFS securities. Firms smooth earnings only when their net income is positive or when net income is negative and the gains from AFS securities are large enough to offset negative earnings. We do not find supporting evidence for engaging in big bath earnings management through the realization of losses on AFS securities. These findings suggest that gains and losses on AFS securities allow non‐financial firms to actively smooth their earnings. Last, the accounting standards amendments in 2017 that essentially disable earnings smoothing through AFS securities increase price efficiency.

Attention Profitability, Leverage, Managerial Ownership and Firm Size Effect on Big Bath Accounting

This research examines the impact of big bath accounting on profitability, leverage, managerial ownership, and firm size. The study used thirty-three firms published on Indonesia Stock Exchange from 2016 to 2020 with 165 observational data. The pattern was analyzed using a logistic regression pattern of variable relationships with SPSS Version 26 software. The result indicates that profitability and leverage significantly influence big bath's accounting treatment so that managers will tend to consider doing big bath accounting at an unfavorable level of profitability and leverage. However, managerial ownership and firm size have no significant impact on big bath accounting. Managers will not continue undertaking extensive bath accounting to maintain the firm's impression among the public. Next research could enhance sample firms and the number of observation periods. Subsequent analysis should find a dependent variable that is not binomial or dichotomy better to reflect the recognition of big bath accounting in firms. The research give suggestions for investor to predict indication of big bath accounting in mining firm at Indonesian Stock Exchange. Keywords: Profitability, Leverage, Managerial Ownership DOI: 10.7176/RJFA/14-4-03 Publication date: February 28 th 2023

Unknown Unknowns: Knightian Uncertainty and Corporate Opportunistic Earnings Management

AbstractUncertainty is inherent in the real world. Faced with Knightian uncertainty caused by many extreme events, this paper focuses on the analysis of corporate opportunistic earnings management behaviour under the unknown unknowns framework. This paper finds that with an increase in market Knightian uncertainty, corporations will significantly adopt both accrual earnings management and real earnings management. More importantly, when compared with upward earnings management, the results indicate that Knightian uncertainty will lead corporations to implement more downward earnings management. Our results are consistent with the big bath theory, which is also verified through the adjustment of non‐recurring profit and loss accounts. To understand the real process of earnings management, we also discuss the strategic choice behaviour of earnings management under different heterogeneous situations.

Big Bath Accounting in an Emerging Market: Evidence from Newly Appointed CEOs in Brazil

Big Bath Accounting in an Emerging Market: Evidence from Newly Appointed CEOs in Brazil

The Effect of Natural Disasters on Big Bath Earnings Management of Banks: Evidence From the 2005 U.S. Hurricane Season

The Effect of Natural Disasters on Big Bath Earnings Management of Banks: Evidence From the 2005 U.S. Hurricane Season

Confucianism and the altruistic behaviour in the succession of family firms: evidence from asset write-downs

ABSTRACT This paper explores how Confucianism influences the altruistic behaviour during family firm successions. Using a sample of Chinese listed family firms which have transferred the power to family successors during 2005-2018, we find that family firms deeply influenced by Confucianism intend to take a big bath via asset write-downs in the year before the succession. Confucianism has stronger influence on altruism when the successor have closer blood relationship with the founder, when the successor is less educated, when the family have weaker control over the firm or when the firm is in a lower market position. When the board of directors is more independent or the auditor has higher reputation, the influence of Confucianism is weaker. Family firms with more asset write-downs have better short-term performance after the succession, but lower business reform and R&D inputs. These findings enrich the research on Confucianism and corporate governance of family firms.

The Role of the Effectiveness of Accounting Information Systems in the Relationship between the Earnings Management and Financial Performance

The effectiveness of the Accounting Information System (AIS) is expected to strengthen mechanisms leading to the efficient functioning of capital markets. AIS provides information that flows from the firm to stakeholders continuously. This flow of information forms the basis for the decision-making of the stakeholders. Therefore, the published periodical financial reports are expected to be relevant, faithfully represented, comparable, verifiable, timely, and comprehensible (Qatawneh, 2022). Additionally, international financial reporting standards provide management with a wide scope for choosing from different alternatives to treat the same transaction or event. Management can misrepresent the timing, amount, or intent of transactions and events related to revenues or expenses without being involved in fraud or falsification of the records (Gul et al., 2013; Kwon et al., 2020). Moreover, management can take advantage of generally accepted accounting principles (GAAP) to select from various methods when computing earnings and other financial measures, which could lead to lower-quality financial information (Fields et al., 2018). This discretionary room allows management to report the desired profit, achieving its goals in the interest of other parties. As a result, phrases such as earnings management and manipulation have emerged. Management can manage earnings by classifying good (bad) news, smoothing income, practicing big bath accounting, and choosing from different accounting methods (Brad et al., 2020), which is known as accruals-based earnings management. Keywords: Accounting, AIS, Earning Management, Financial Performance. DOI: 10.7176/RJFA/13-24-07 Publication date: December 31 st 2022

Epistimologi Penetapan Masa Haidh Istri melalui Pendekatan Ilmu Qiraat al-Quran dalam Perhitungan Masa Haidh Istri

The birth of Islamic law schools in the study of jurisprudence such as the Shafi'iyah, Malikiyah, Hanbaliyah, Hanafiyah, Zhahiriyah, and so on is an implication of the differences in qiraat in the verses of the Quran. They interpreted the verses of the Quran with the basic raw material being instructions on the qiraat ordinances which were complemented by the rules of irab, shighat, and grammatical arrangements of arabic linguistic rules. The research uses a qualitative approach with a library research method approach. The purpose of this study is to understand the methodology of taking Islamic law carried out by mujtahid fiqh; and how the form of the legal product resulted from the difference in qiraat. The results of this study show that the legal case of differences in qiraat to the legal status of a wife who is menstruating (QS. al-Baqarah: 222) which gives birth to three different interpretations, namely: The Hanafi Imam School is of the view that a wife is considered holy from the menstrual state, if her menstrual blood has stopped. The jumhur school/majority of scholars consisting of imams Maliki, Shafi'i, and Hanbali are of the view that the sacred condition of a wife who is menstruating is that when she has done a big bath, then a husband is justified to take her captive. It is not permissible for the husband to take care of a wife, even though she has stopped her menstrual blood, but the wife has done a big bath. Mazhab al-Thawas and al-Mujahid argue that it is permissible for the husband to treat his wife who is menstruating by washing the wife's, then she is in the form and allowed to perform prayers immediately.