EconPapers    
Economics at your fingertips  
 

Can “Big Bath” and Earnings Smoothing Co‐exist as Equilibrium Financial Reporting Strategies?

Michael Kirschenheiter and Nahum D. Melumad

Journal of Accounting Research, 2002, vol. 40, issue 3, 761-796

Abstract: We study a model of financial reporting where investors infer the precision of reported earnings. Reporting a larger earnings surprise reduces the inferred earnings precision, dampening the impact on firm value of reporting higher earnings, and providing a natural demand for smoother earnings. We show that for sufficiently “bad” news, the manager under‐reports earnings by the maximum, preferring to take a “big bath” in the current period in order to report higher future earnings. If the news is “good,” the manager smoothes earnings, with the amount of smoothing depending on the level of cashflows observed. He either over‐reports or partially under‐reports for slightly good news, and gradually increases his under‐reporting as the news gets better, until he is under‐reporting the maximum amount for sufficiently good news. This result holds both when investors are “naïve” and ignore management’s ability to manipulate earnings, or “sophisticated” and correctly infer management’s disclosure strategy.

Date: 2002
References: Add references at CitEc
Citations: View citations in EconPapers (62)

Downloads: (external link)
https://doi.org/10.1111/1475-679X.00070

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:joares:v:40:y:2002:i:3:p:761-796

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=0021-8456

Access Statistics for this article

Journal of Accounting Research is currently edited by Philip G. Berger, Luzi Hail, Christian Leuz, Haresh Sapra, Douglas J. Skinner, Rodrigo Verdi and Regina Wittenberg Moerman

More articles in Journal of Accounting Research from Wiley Blackwell
Bibliographic data for series maintained by Wiley Content Delivery ().

 
Page updated 2025-03-19
Handle: RePEc:bla:joares:v:40:y:2002:i:3:p:761-796