Implantation of Big Bath Theory

Implantation of Big Bath Theory

Possible motivations for an “earnings bath”
ii. How an “earnings bath” may be achieved
iii. Whether an “earnings bath” has implications for a firm’s share price
iv. Whether an “earnings bath” has implications for the value of a firm’s stock options.

Please make introduction.



According to the Big Bag Hypothesis of earnings management, companies that have registered remarkably low earnings in the current year are likely to use their discretion to take large write-downs and record much more reduced earnings (Jordan & Clark, 2004). This theory is based on the idea that punishment for the management and the company would not necessarily be proportionate to the percentage of lower earnings registered, thus, in case of lower earnings, the lower the better as it makes any future increment significantly noteworthy (Tokuga & Yamashita, 2011).

This report finds substance in the remarks made by the new CEO of Factional Ltd in relation to the context to the Big Bath Hypothesis as a likely tool for earnings management (Riahi-Belkaoui, 2004); outlining what the motivations, the CEO would have to want to do this as his first order of business. According to Deegan (2014)  the report further finds sufficient evidence that an ’earnings bath’ will most certainly have capital markets impacts by affecting both the share price and the value of stock options of a firm, positively. The justification derives on the principles of Capital Market Research and Behavioral Research.


Findings and Discussion


Motivations for an “earnings bath” how to achieve it and the implications of an “earnings bath” for a firm’s share price and for the value of a firm’s stock option


Companies have been known to use creative accounting to their advantage and the “Big Bath Theory” is one of the finest ways to go about it, according to findings by Deegan (2014) in his analysis of the reaction of capital markets to financial reporting and behavioral research. If a company wants to be placed at a high premium by stock analysts of the capital markets, manipulating their earnings to give the impression of a steady annual rise in earning may achieve this result. This is in line with the efficient markets hypothesis, which bases the efficiency of a market on its ability to assimilate swiftly released financial reporting information and effectively adjust the prices of shares. In this case, of ‘taking a bath’ Deegan (2014) emphasizes the impact of semi-strong forms of information efficiency, which constitutes financial statements and other disclosures using the findings of both value relevance and information content capital markets research. By using finance, theory in capital markets research, Deegan (2014) examines and proves that historical earnings combined with current

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