Sudden loss, corporate governance structure, and big bath behavior: Evidence from Egypt

Abstract

This study investigates the effect of sudden loss on corporate governance structure (CGS), and its implications on earnings management technique “big bath” in the Egyptian context. A matched sample of 208 firm-year observations in the Egyptian Stock Exchange (EGX) has been examined. Using the same methodology as in Mulcahy and Donnelly (2015) and Cheng, Park, Pierce, and Zhang (2019), the difference-in-differences (DID) approach is applied to measure the response of CGS to sudden loss versus profit incident, while binary logistic regression is used to investigate big bath following. Results indicate a significant association of sudden loss on changes in the loss firms’ CGS following the loss, although these changes do not significantly differ from those made by profit firms. This indicates that sudden loss may trigger changes in corporate governance (CG), but other conditions also play a role in evoking such changes. Results also show a significant positive association of sudden loss on increasing the likelihood of engaging in a big bath behavior. The findings of this study are expected to help Egyptian firms’ managers to improve firms’ performance and governance structure that lead to high-quality earnings and provide financial reports that rationalize investors’ decisions. This study is the first to test the influence of sudden loss on CGS and link it to big bath in Egyptian setting.