Earnings Management in the Banking Industry

Executive summary Prior research suggests that banks have an incentive to smooth income through loan loss provisions (LLPs), but there has been no research on the effects of IFRS implementation on this. Using a sample of European banks and a single-stage regression that models the nondiscretionary part of LLPs and tests for income smoothing I examine first whether the level of earnings management by banks through loan loss provisioning has decreased since the IFRS-adoption. And second, whether loan loss disclosure requirements are negatively related to banks’ income smoothing. Results show that the level of earnings management has indeed decreased since IFRS adoption. However, evidence suggests that detailed disclosure requirements regarding loan loss accounting do not deter bank managers from using LLPs to their discretion for income smoothing.

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