۱- Introduction

۲- Related literature and hypotheses

۳- Methodology

۴- Sample

۵- Results

۶- Conclusion

References

Abstract

We study the effects of country-level accounting enforcement on earnings quality of banks and whether bank regulation substitutes or complements the effect of accounting enforcement on bank earnings quality. We also examine whether the influence of accounting enforcement on bank earnings quality changed after the global financial crisis. Using a sample of listed banks from 40 countries between 2001 and 2014, and abnormal loan loss provisions (ALLP) as our main proxy for earnings quality, we document a consistent and strong association between accounting enforcement and bank earnings quality. More specifically, an increase in accounting enforcement decreases the level of ALLP and decreases the propensity to manage earnings to avoid losses. Furthermore, we provide empirical evidence that bank regulation complements the effect of accounting enforcement on bank earnings quality. Finally, unlike in the pre-crisis period, we find a positive association between accounting enforcement and income-decreasing ALLP in the post-crisis period, which indicates that stronger accounting enforcement is associated with more conservative earnings and higher loan loss reserves. Overall, our results indicate that accounting enforcement reduces opportunistic earnings management.

Introduction

We investigate the relation between country-level accounting enforcement and earnings quality of banks for a sample of publiclylisted international banks. We first examine how accounting enforcement by itself relates to bank earnings quality and then we examine the implications of bank regulation for the accounting enforcement-earnings quality relation. We also study whether the effect of accounting enforcement on earnings management changed after the global financial crisis. Banking is a unique industry where accounting standard setters and regulatory agencies may not always have similar objectives to bank regulators. Whereas accounting standard setters and regulators are more concerned about transparent financial reporting that reflects true economic performance, bank regulators may prefer conservative accounting practices that can lead to over-provisioning of allowances for bad loans that act as a cushion against financial difficulties in bad times. For example, banks’ loan loss provisioning practices came under scrutiny by the SEC’s task force on earnings management (The Wall Street Journal, November 16, 1998). This emphasis on reserves stems from the SEC’s broader concerns about earnings management in banking and other industries. Whereas some banks were trimming loss reserves to increase earnings and bolster their return on equity, other banks were being conservative by overly provisioning for loan losses (American Banker, June 29, 1998). In response to this concern, the SEC on November 16, 1998 ordered SunTrust bank to trim its 1994, 1995, and 1996 loan loss provisions, which resulted in an upward restatement of SunTrust’s profits for the three years and a reduction in its loan loss reserves to $666 million from $766 million.