Earnings management and equity incentives: evidence from the European banking industry

2019 ◽  
Vol 27 (2) ◽  
pp. 244-261 ◽  
Author(s):  
Mohammad Alhadab ◽  
Bassam Al-Own
Keyword(s):  
Earnings Management ◽  
Management Practices ◽  
Banking Industry ◽  
Future Research ◽  
Loan Loss ◽  
Content Type ◽  
Loan Loss Provisions ◽  
Equity Incentives ◽  
European Banking ◽  
European Banks

Purpose This study aims to examine the effect of equity incentives on earnings management that occurs via the use of loan loss provisions by using a sample of 204 bank-year observations over the period 2006-2011. Design/methodology/approach The authors use the data of 39 European banks to test the main hypothesis. Several valuation models and regressions are used to measure the main proxies for executives’ compensation and the determinant factors of loan loss provisions. Findings The empirical results reveal that earnings management that occurs via discretionary loan loss provisions is associated with equity incentives in the banking industry. In particular, European banks’ executives with high equity incentives are found to manage reported earnings upwards by reducing loan loss provisions. The results therefore show that income-increasing earnings management via discretionary loan loss provisions is widely practised by the executives of European banks and that this is partly motivated by executives’ compensation. Practical implications The findings of this paper present important implications for regulators in the European Union, who should take further steps to reform the regulatory environment to monitor and mitigate the earnings management practices that occur via the manipulation of loan loss provisions. Earnings management practices do not just negatively affect subsequent performance but are also found to lead to firms’ failure. Thus, regulators should take the necessary reforms to protect the wealth of stakeholders (investors, creditors, etc.). Originality/value This study provides the first evidence on the relationship between equity incentives and earnings management in the European banking industry. The study sheds more light on an issue of great interest to a broad audience that does not receive much attention in the prior research, thus opening new avenues for future research.

Earnings management and evolution of the banking regulation

2015 ◽  
Vol 5 (2) ◽  
pp. 150-169 ◽  
Author(s):  
Sarra Hamza Elleuch ◽  
Nelia Boulila Taktak
Keyword(s):  
Earnings Management ◽  
Management Practices ◽  
Mixed Model ◽  
Banking Regulation ◽  
Loan Loss ◽  
Content Type ◽  
Loan Loss Provisions ◽  
Qualitative Approaches ◽  
The Impact ◽  
The Imf

Purpose – The purpose of this paper is to examine the earnings management practices of Tunisian banks after the publication of the first International Monetary Fund (IMF) report (2002) over the period 1998-2007. Design/methodology/approach – The study relies on a mixed model that combines both the quantitative and qualitative approaches. First of all, we use the quantitative method to measure the discretionary loan loss provisions based on the model of Cornett et al. (2009), and then we validate the quantitative findings by using the interview approach. Findings – Since 2005, Tunisian banks have resorted less and less to accounting earnings management through the loan loss provisions, but conversely, real earnings management has been revealed instead by the sale of investment securities and the use of debt collection agencies. Despite the IMF recommendations, Tunisian banks continue to manage their earnings by changing only their strategies. Practical implications – The findings of this study show that the regulation cannot avoid earnings management. Even if the regulation limits the discretion of the manager, the latter finds new alternatives to manipulate the earnings. Originality/value – This is the first study that analyses the impact of the IMF recommendations on earnings management in an emerging economy.

The determinants of bank profitability: empirical evidence from European banking sector

2016 ◽  
Vol 14 (1) ◽  
pp. 86-115 ◽  
Author(s):  
Elisa Menicucci ◽  
Guido Paolucci
Keyword(s):  
Banking Sector ◽  
Developed Countries ◽  
Policy Implications ◽  
Loan Loss ◽  
Data Set ◽  
Bank Profitability ◽  
Content Type ◽  
Loan Loss Provisions ◽  
European Banking ◽  
European Banks

Purpose The purpose of this paper is to investigate the relationship between bank-specific characteristics and profitability in European banking sector to find the role of internal factors in achieving high profitability. Design/methodology/approach A regression analysis is built on an unbalanced panel data set comprising 175 observations of 35 top European banks over the period 2009-2013. To this end, the empirical data are collected from Bankscope and a comprehensive set of internal characteristics is examined. Findings All the determinant variables included in the model have statistically significant impacts on European banks’ profitability. However, the effects are not uniform across profitability measures. Regression findings reveal that size and capital ratio are significant company-level determinants of bank profitability in Europe, while higher loan loss provisions result in lower profitability levels. Findings also suggest that banks with higher deposits and loans ratio tend to be more profitable but the effects on profitability are statistically insignificant in some cases. Practical implications This study has considerable policy implications, as the performance of the European banking sector depends on its efficiency, profitability and competitiveness. In view of these findings, some suggestions may be functional for bank regulatory authorities to intensify and sustain robustness and stability of the banking sector. Originality/value The results provide interesting insights into the characteristics and practices of profitable banks in Europe. Few econometric studies have empirically explored the determinants of bank profitability in Europe so far, even though similar studies have been conducted in several developed countries. Therefore, this paper tries to close an important gap in the existing literature improving the understanding of bank profitability in Europe.

scholarly journals Impact of IAS 39 reclassification on income smoothing by European banks

2019 ◽  
Vol 17 (3) ◽  
pp. 537-553
Author(s):  
Peterson K. Ozili
Keyword(s):  
Income Smoothing ◽  
International Accounting ◽  
Loan Loss ◽  
Content Type ◽  
Loan Loss Provisions ◽  
Before And After ◽  
European Banking ◽  
European Banks ◽  
Ias 39 ◽  
The Impact

Purpose The purpose of this study is to examine the impact of the reclassification of International accounting standard (IAS) 39 on income smoothing using loan loss provisions among European banks. Design/methodology/approach Regression methodology is used to determine the extent of income smoothing using loan loss provisions before and after IAS 39 reclassification. The authors predict that the strict recognition and re-classification requirements of IAS 139 reduced banks’ ability to smooth income using bank securities and derivatives, motivating them to rely more on loan loss provisions to smooth income. The authors test this hypothesis over a sample of 114 European banking institutions over the period 2005 to 2013. Findings The findings do not support the prediction for income smoothing through loan loss provisions. Also, there is no evidence for income smoothing in the pre- and post-IAS 39 reclassification period. Research limitations/implications The implication of the findings is that the European banks did not use loan loss provisions to smooth income during the period examined, and rather rely on other accounting numbers to smooth income. This implies that the International Accounting Standards Board’s strict disclosure regulation improved the reliability and informativeness of loan loss provision estimates among European banks during the period of analysis. Originality/value This study is the first attempt to analyze the effect of IAS 39 re-classification on bank’s ability to smooth income in Europe.

scholarly journals Does the New European Banking Regulation discourage Earnings Management?

2017 ◽  
Vol 10 (10) ◽  
pp. 45 ◽  
Author(s):  
Giuseppe Di Martino ◽  
Grazia Dicuonzo ◽  
Graziana Galeone ◽  
Vittorio Dell'Atti
Keyword(s):  
Earnings Management ◽  
Financial Reporting ◽  
Banking Sector ◽  
Banking Regulation ◽  
Regulatory Framework ◽  
Loan Loss ◽  
Minimum Capital ◽  
Loan Loss Provisions ◽  
European Banking ◽  
Single Rulebook

In the recent past, the financial crisis has shown important lacks in the EU regulation relating to the banking sector, making the introduction of a unified regulatory framework necessary. Since June 2009 the European Council has recommended a “Single Rulebook”, that is a unique and harmonizing discipline applicable to all financial institutions in the Single Market, become effective on January 2014. This prudential discipline requires much more minimum capital, liquidity and information transparency and it defines format and minimum standards of contents.The aim of this research is to investigate the relation between the new mandatory disclosure and earnings management policies in banking sector realized through Loan Loss Provisions (LLP), the component of income statement mainly subject to manipulations, especially in form of earnings smoothing. Because the new integrated regulatory framework requires a more transparent disclosure, we expected that accruals manipulation (basically LLP) could be discouraged. The empirical analysis is based on a sample of 116 listed European banks over the period prior (2011-2012-2013) and after (2014-2015-2016) the effective date of the Single Rulebook. The evidence confirm our hypothesis suggesting that this banking reform discourages earnings manipulation and improves earnings quality, making financial reporting more useful for investors. The results are important to the regulatory institutions (such as European Union and European Central Bank) supporting more stringent discipline introduced by Basel III.

Loan Loss Provisions and Earnings Management in Malaysian Banking Industry

2013 ◽  
Vol 1 (1) ◽  
pp. 93-104
Author(s):  
Hasni Abdullah ◽  
Imbarine Bujang ◽  
Ismail Ahmad
Keyword(s):  
Earnings Management ◽  
Commercial Banks ◽  
Global Financial Crisis ◽  
Banking Industry ◽  
Least Square ◽  
Capital Management ◽  
Loan Loss ◽  
Macroeconomic Factors ◽  
Ordinary Least Square ◽  
Loan Loss Provisions

Objective The main purpose of the study is to investigate the presence of earnings management incentive in affecting the LLP decision of commercial banks in Malaysia, focusing on the relation between loan loss provisions and earnings before tax and provisions. Methodology/Technique This study applies the pooled Ordinary Least Square model in assessing the determinants of the LLP. Findings The empirical findings clearly indicate that the LLP in Malaysian commercial banks is affected by earnings management for that particular period Type of Paper: Empirical paper Novelty : The expansion of the existing research in Malaysia in order to examine the extent to which the Malaysian banks engage in earnings and capital management, extends the period of investigation by considering the recent global financial crisis 2007-2009. Keywords: Loan Loss Provisions; Earnings Management; Capital Management; Macroeconomic Factors; Commercial Banks.

scholarly journals Does banking oversight make financial statements more reliable? An analysis through countries which are part of the Single Supervisory Mechanism (SSM)

2019 ◽  
Vol 16 (3) ◽  
pp. 36-51
Author(s):  
Giacomo Ceccobelli ◽  
Alessandro Giosi
Keyword(s):  
Earnings Management ◽  
Banking Industry ◽  
Financial Statements ◽  
Income Smoothing ◽  
Capital Management ◽  
Loan Loss ◽  
Single Supervisory Mechanism ◽  
Loan Loss Provisions ◽  
Regulation And Supervision ◽  
Bank Regulation And Supervision

The purpose of this research is to investigate earnings management purposes in the banking industry via loan loss provisions using a sample of 156 banks from 19 European countries under the Single Supervisory Mechanism (SSM) over the period 2006-2016. Using regression analysis, banks are tested for income smoothing, capital management, and signaling purposes. This study contributes to the literature exploring the relationship between accounting quality and earnings management objectives by analyzing which one of the latter is the more important determinant. The hypotheses of income smoothing and signaling are strongly approved since loan loss provisions consist as a tool for smoothing the amount of net profit and to convey private information to the market; on the contrary, the capital management purpose is not supported. Additionally, the analysis finds that non-discretionary components of loan loss provisions (essentially non-performing loans) have played an important role, especially during the financial crisis. Furthermore, the research is aimed at investigating the peculiar regulatory and supervisory environment in the banking industry on the basis of a set of indexes included in the “Bank Regulation and Supervision Survey”, carried out by the World Bank. Unlike previous literature, this study takes into account the latest release of the survey, emphasizes the role of an on-site inspection as the main supervisory tool and extends the analysis of the interaction between bank regulation and supervision and earnings management. The results demonstrate that such controls can influence the behaviour of bank managers in terms of income smoothing and signaling practices. Therefore they can be considered as effective instruments for reducing banks’ management accounting discretion, making financial statements more reliable.

A review of the influence of political connections on management’s decision in non-US settings

2020 ◽  
Vol 18 (4) ◽  
pp. 687-705
Author(s):  
Ines Amara ◽  
Hichem Khlif
Keyword(s):  
Earnings Management ◽  
Voluntary Disclosure ◽  
Management Practices ◽  
Empirical Studies ◽  
Tax Avoidance ◽  
Economic Effects ◽  
Real Earnings Management ◽  
Political Connections ◽  
Future Research ◽  
Content Type

Purpose Given the interest in better understanding the economic effects of political connections, this paper aims to review empirical studies in the accounting and finance domain investigating the effects of firms’ political connections on management’s decision in non-US settings. Design/methodology/approach Key words used to search for relevant studies include “political connections” linked with “tax avoidance,” “earnings quality” “voluntary disclosure.” The authors consult several editorial sources including Elsevier, Electronic Journals Service EBSCO, Emerald, Springer, Palgrave Macmillan, Sage, Taylor & Francis and Wiley-Blackwell. The authors’ search yields 46 published studies since 2006. Findings The review reveals a prevalence of studies conducted in Asia. A narrative synthesis of empirical findings shows mixed effects of political connections on earnings management, as measured by accrual-based or real earnings management practices. Mixed evidence also exists for the association between political connections and reporting policy (e.g. corporate social responsibility reporting). The review also reveals that firms with political ties adopt an aggressive tax policy aimed at reducing effective tax rates and are more likely to choose a Big 4 auditor. Originality/value The review discusses the political connections literature focusing on studies outside of the USA and the effect of such connections on decision-making by management. It identifies some limitations of this literature and offers guidance for future research avenues. The synthesis suggests that political connections can adversely or beneficially impact management’s decisions depending on the legal, institutional and cultural characteristics prevailing in a particular setting.

scholarly journals Discretionary provisioning practices among Western European banks

2017 ◽  
Vol 9 (1) ◽  
pp. 109-118 ◽  
Author(s):  
Peterson K. Ozili
Keyword(s):  
Financial Crisis ◽  
Credit Risk ◽  
Income Smoothing ◽  
Least Square ◽  
Loan Loss ◽  
Content Type ◽  
Crisis Period ◽  
Loan Loss Provisions ◽  
European Banks ◽  
Western European

Purpose The purpose of the study is to investigate whether discretionary ‘loan loss provisioning’ by Western European banks is driven by income smoothing or credit risk considerations. Design/methodology/approach To test the income smoothing hypothesis, the study uses ordinary least square regression to examine the relation between loan loss provisions and earnings before tax and loan loss provisions in the post-financial crisis period. Findings The authors find evidence that discretionary provisioning by Western European banks is driven by income smoothing incentives in the post-financial crisis period, particularly, among listed banks. Also, it is observed that discretionary provisioning is significantly influenced by credit risk factors, mainly, non-performing loans and loan growth. Also, it is found that discretionary provisioning by Western European banks is procyclical with fluctuations in the economic cycle. Overall, the implication of the findings is that discretionary provisioning among Western European banks is driven by both income smoothing and credit risk considerations. Originality/value This study focus on banks in Western Europe in contrast to prior European studies.

scholarly journals Discretionary Loan Loss Provisions, Earnings Management and Capital Management in Banks

2019 ◽  
Vol 15 (7) ◽  
pp. 144
Author(s):  
Amina Zgarni ◽  
Hassouna Fedhila
Keyword(s):  
Earnings Management ◽  
Financial Reporting ◽  
Management Practices ◽  
Reporting Quality ◽  
International Standards ◽  
Financial Reporting Quality ◽  
Regulatory Capital ◽  
Loan Loss ◽  
Loan Loss Provisions ◽  
Financial Scandals

The two past decades have been marked by a multitude of financial scandals (the Enron failure, WorldCom. etc.) mainly caused by the practices of earning management that have challenged the financial reporting quality disclosed. The purpose of this research is to study the determinants of discretionary loan loss provisions in banks. To achieve this objective, we selected a sample of the main Tunisian banks over the period from 2001 to 2014. The estimation results shows that the banks are opting for earnings management practices through the discretionary loan loss provisions in order to align with international standards, in particular with respect to regulatory capital. In opposition, we found a non-significant relationship between earnings before taxes and provisions and discretionary provisions.

scholarly journals Banking sector earnings management using loan loss provisions in the Fintech era

2020 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Peterson K. Ozili
Keyword(s):  
Earnings Management ◽  
Banking Sector ◽  
Income Smoothing ◽  
Loan Loss ◽  
Content Type ◽  
Eu Countries ◽  
Loan Loss Provisions ◽  
Country Level ◽  
Show Evidence ◽  
Second Wave

PurposeThis paper analyzes banking sector earnings management using loan loss provisions (LLPs) in the Fintech era.Design/methodology/approachRegression methodology was used to examine earnings management in the Fintech era.FindingsThe findings show evidence for bank income smoothing using LLPs. There is greater income smoothing in the second-wave Fintech era compared to the first-wave Fintech era, and the presence of strong institutions did not lower income smoothing in the second-wave era. Bank income smoothing is also greater in (1) Bank of International Settlement (BIS) and EU countries than in non-EU countries and G7 countries, (2) well-capitalized banking sectors and (3) during economic booms in the second-wave Fintech era.Practical implicationsThe competition for loans and deposits by banks and Fintech lenders in the second-wave Fintech era created additional incentives for banks to engage in income smoothing to report competitive and stable earnings.Originality/valueThe study uses a unique approach to detect country-level earnings management in the banking sector. Also, this study extends the bank earnings management literature by introducing the Fintech era as a determinant of the extent of bank earnings management.

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