Big Bath Accounting Following Natural Disasters

43 Pages Posted: 6 Jan 2019 Last revised: 21 Oct 2020

See all articles by Yingmei Cheng

Yingmei Cheng

Florida State University - College of Business

Jonghan Park

The Chinese University of Hong Kong, Shenzhen - School of Management and Economics

Spencer Pierce

Florida State University - College of Business

Tianming Zhang

Florida State University - Department of Accounting

Date Written: December 19, 2019

Abstract

Practitioners and academics widely suspect that managers engage in “big bath” reporting behavior as a form of earnings management, but conclusive evidence of this behavior has been difficult to document due to the inherently endogenous nature of reporting the large nonrecurring charges necessary to engage in a big bath. We introduce a novel dataset of natural disasters to address this problem and argue that natural disasters provide an ideal exogenous shock to examine big baths. Consistent with opportunistic reporting, we find that, relative to both matched firms unaffected by a natural disaster and matched firms affected by the same natural disaster that do not report large, negative special items, big bath firms experience greater improvements in post-disaster earnings for multiple years and higher future stock returns. We also find that CEOs of bath firms receive relatively larger increases in bonus and cash compensation in the years following the natural disaster. Overall, our evidence suggests that managers take advantage of the occurrence of natural disasters by engaging in opportunistic big bath reporting behavior.

Keywords: Natural disasters, big bath accounting, earnings management

JEL Classification: M41, G32

Suggested Citation

Cheng, Yingmei and Park, Jonghan and Pierce, Spencer and Zhang, Tianming (Tim), Big Bath Accounting Following Natural Disasters (December 19, 2019). Available at SSRN: https://ssrn.com/abstract=3305478 or http://dx.doi.org/10.2139/ssrn.3305478

Yingmei Cheng

Florida State University - College of Business ( email )

423 Rovetta Business Building
Tallahassee, FL 32306-1110
United States
850-644-7869 (Phone)

Jonghan Park

The Chinese University of Hong Kong, Shenzhen - School of Management and Economics ( email )

2001 Longxiang Road, Longgang District
Shenzhen, 518172
China

Spencer Pierce

Florida State University - College of Business ( email )

423 Rovetta Business Building
Tallahassee, FL 32306-1110
United States

Tianming (Tim) Zhang (Contact Author)

Florida State University - Department of Accounting ( email )

Rovetta Business Bldg. (RBA)
College of Business
Tallahassee, FL 32306-1110
United States

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