Do baths muddy the waters or clear the air?

  • Haggard K
  • Howe J
  • Lynch A
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We examine the information environments of firms following large, non-recurring charges ("baths"). We test competing hypotheses about the consequences of a bath-a bath either improves the information environment (the transparency hypothesis) or degrades it (the opacity hypothesis). Difference-in-differences analysis suggests that after a bath (1) earnings become smoother, (2) firm-level information asymmetry decreases, and (3) stock returns become more responsive to unexpected earnings. We interpret these findings as supportive of the transparency hypothesis. We also document that the relative improvement in the information environment is greater for baths that are not voluntary, consistent with managerial obfuscation prior to the bath.

Author-supplied keywords

  • Earnings responsiveness
  • Earnings smoothing
  • Information asymmetry

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  • K. Stephen Haggard

  • John S. Howe

  • Andrew A. Lynch

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