The Big Bath Strategy

Perumaal K

25 Sep 2026 — 1 min read

The Securities and Exchange Board of India (SEBI) and the National Financial Reporting Authority (NFRA) prohibit companies from going too far in prettifying their profits to pump up their share prices. These regulators refrain from indicating exactly how far is too far. For some withholding an information is not a lie unless somebody asks for it. And a number of research also indicate that the quality of being open, honest, and sincere in financial reporting is lacking and widespread.

By the laws of probability, it is very common that company's quarterly reports in many cases of earnings would have barely exceeded or fall just shy of year-earlier results. The findings showed that when companies were in danger of having slightly negative earnings comparisons, they found enough discretionary items to project a marginally improved results. And statistics proved that companies posted small increases far more frequently than they posted small declines.

But, suppose a company suffers a quarterly profit decline too large to manipulate through discretionary items, such circumstances create an opportunity to take a big bath. Management "takes a bath" (clearing the slate) by bundling all possible future losses, asset write-downs, or prepaid costs into the current accounting period, by pushing current net income down as far as possible, and thereby boosting future results. The reasoning is that investors will not be much more disturbed by a 30 percent drop in earnings by a 20 percent drop. In fact, the companies may take a larger write-off on those assets than an accurate representation would dictate. The same research statistics corroborate the big bath hypothesis by showing that large earnings decline were more common than large increases.

So, the overall impression is that companies regard financial reporting as a technique for propping up stock prices, rather than a means of disseminating objective information.

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