EARNINGS MANAGEMENT, CAPITAL MANAGEMENT, SIGNALLING AND THE COVID-19 PANDEMIC: THE CASE OF LISTED BANKS IN THE UNITED STATES

Year 2023, , 170 - 181, 30.09.2023

Ikechukwu Ndu , Emmanuel Anoruo , Chiaku Chukwuogor

https://doi.org/10.17261/Pressacademia.2023.1815

Abstract

Purpose- This paper investigates earnings management, capital management, the impact of the Covid-19 pandemic and signalling by United States listed banks of loan loss provisions. This study is particularly important because there is a relative dearth of research in banking on these topics and thus remain considerably under researched.
Methodology- The dataset comprises a pooled cross-sectional and time series data for a sample of 249 U.S. listed banks for the period 2015 to 2020 consisting of 1,494 observations. A panel data analysis is conducted.
Findings- Results overall show no evidence of systematic earnings management, capital management or signaling by the banks. Findings reveal the impact of the Covid-19 pandemic is not significant during this period of economic fragility for listed banks. The elasticity of loan loss provisions with regards to the annual growth in gross domestic product is negative and statistically significant overall. This is evidence that U.S. listed banks’ loan loss provisioning exhibits a pro-cyclical nature. Overall, these results provide evidence of the success of restrictions due to tighter bank regulation and supervision that came into effect at the end of 2014. This required U.S. banks to maintain a minimum common equity tier 1 capital ratio of 4 percent, a minimum tier 1 capital ratio of 5.5 percent, a minimum total capital ratio of 8 percent, and a minimum leverage ratio of 4 percent.
Conclusion- This study adds to the literature as it provides evidence that restrictions on bank activities in the form of minimum capital and leverage ratios at the end of 2014, restrictions in the use of bank capital, and extension of financial support via government intervention funding during the Covid-19 pandemic crisis period have reduced incentives to smooth earnings in the United States banking system. It therefore represents a tried and tested model that can be adopted by banking systems in other countries.

Keywords

Banks, capital management, COVID-19 pandemic, earnings management, loan loss provision, signalling

References

• Ahmed, A., Takeda, C., and Thomas, S. (1999). Bank loan loss provisions: a re-examination of capital management, earnings management and signaling effects. Journal of Accounting and Economics, 29, 1-25.
• Anandarajan, A.; Hasan, I., and Lozano-Vivas, A. (2003). The role of loan loss provisions in earnings management, capital management and signalling: the Spanish experience. Advances in International Accounting, 16, 45-65.
• Anandarajan, A., Hasan, I. and McCarthy, C.H. (2007). Use of loan loss provisions for capital, earnings management and signalling by Australian bank. Accounting and Finance, 47(3), 357-379.
• Arellano, M., and Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277-297.
• Basu, S., Vitanza, J. and Wang, W. (2020). Asymmetric loan loss provision models. Journal of Accounting and Economics, 70(2/3), 79-91.
• Beatty, A., Chamberlain, S. and Magliolo, J. (1995). Managing financial reports of commercial banks: the influence of taxes, regulatory capital and earnings. Journal of Accounting and Economics, 28, 1-25.
• Beaver, W., and Engel, E. (1996). Discretionary behaviour with respect to allowances for loan losses and the behaviour of stock prices. Journal of Accounting and Economics, 22, 177-206.
• Bhat, V. (1996). Banks and income smoothing: an empirical analysis. Applied Financial Economics, 6, 505-510.
• Bikker, J.A., and Metzemakers, P.A.J. (2005). Banks provisioning behavior and procyclicality. Journal of International Finance Markets, Institutions and Money, 15(2), 141-157.
• Cohen, L.J., Cornett, M.M., Marcus, A.J., and Tehranian, H. (2014). Bank earnings management and tail risk during the financial crisis. Journal of Money, Credit, and Banking, 46(1), 171-197.
• Collins, J., Shackelford, D., and Wahlen, J. (1995). Bank differences in the coordination of regulatory capital, earnings and taxes. Journal of Accounting Research, 33, 263-292.
• Curcio, D., and Hasan, I. (2013). Earnings and capital management and signaling: the use of loan-loss provisions by European banks. The European Journal of Finance, 21(1), 26-50.
• Domac, I. and Peria, M.S.M (2003). Banking crises and exchange rate regimes: Is there a link? Journal of International Economics, 61, 41-72.
• Fonseca, A.R., and González, F. (2008). Cross-country determinants of bank income smoothing by managing loan-loss provisions. Journal of Banking and Finance, 32, 217-228.
• Gombola, M.J., Ho, A.Y., and Huang, C. (2016). The effect of leverage and liquidity on earnings and capital management: Evidence from U.S. commercial banks. International Review of Economics and Finance, May, 43, 35-58.
• Greenawalt, M.B., and Sinkey, J.F. (1988). Bank loan loss provisions and the income smoothing hypothesis: an empirical analysis, 1976-1984. Journal of Financial Services Research, 1(4), 301-318.
• Healy, P.M., and Whalen, J.M. (1999). A Review of the earnings management literature and its implications for standard setting. Accounting Horizons, 13(4), 365-383.
• Hoggarth, G., Sorensen, S., and Zicchino, L. (2005). Costs of banking system instability: Some empirical evidence. Journal of Banking and Finance, 29, 825-855.
• Kanagaretnam, K., Lobo, G.J., and Yang, D. (2004). Joint tests of signaling and income smoothing through bank loan loss provisions. Contemporary Accounting Research, 21 (4), 843-884.
• Laeven, L., and Majnoni, G. (2003). Loan loss provisioning and economic slowdowns: too much, too late? Journal of Financial Intermediation, Elsevier, 12(2), 178-197.
• Leventis, S., Dimitropoulos, P.E., and Anandarajan A. (2011). Loan loss provisions, earnings management and capital management under IFRS: The case of EU commercial bank. Journal of Financial Services Research, 40(1), 103-122.
• Liu, C., and Ryan, S. (1995). The effect of bank loan portfolio composition on the market reaction to and anticipation of loan loss provisions. Journal of Accounting Research, 33, 77-94.
• Liu, C.; Ryan, S.; and Wahlen, J. (1997). Differential valuation implications of loan loss provisions across bank and fiscal agents. The Accounting Review, 72(1), 133-146.
• Lobo, G.J. and Yang, D.H. (2001). Bank managers’ heterogeneous decisions on discretionary loan loss provisions. Review of Quantitative Finance and Accounting, 16, 223-250.
• Ma, C.K. (1988). Loan loss reserve and income smoothing: The experience in the U.S. banking industry. Journal of Business Finance and Accounting, 15(4), 487-497.
• Mansfield, E. (1962). Entry, Gibrat’s Law, Innovation and the Growth of Firms. The American Economic Review, 42, 479-492.
• Moyer, S.E. (1990). Capital adequacy ratio regulations and accounting choices in commercial banks. Journal of Accounting and Economics, 13, 123-154.
• Pérez, D.; Salas-Fumás, V., and Saurina, J. (2008). Earnings and capital management in alternative loan loss provision regulatory regimes. European Accounting Review, 17, 423-445.
• Roychowdhury, S. (2006). Earnings management through real activities manipulation. Journal of Accounting and Economics, 42(3), 335-370.
• Scheiner, J.H. (1981). Income smoothing: An analysis in the banking industry. Journal of Bank Research, 12, 119-123.
• Scholes, M.; Wilson, G.P., and Wolfson, M. (1990). Tax planning, regulatory capital planning and financial reporting strategy for commercial banks. The Review of Financial Studies, 3, 625-650.
• Tran, D.V., Hassan, M.K., Alam, A.W., and Dau, N. (2022). Banks financial soundness during the Covid-19 pandemic. Journal of Economics and Finance, 46(4), 713-735.
• Watts, R. and Zimmerman, J. (1986). Positive Accounting Theory. Edgewood Cliffs, NJ: Prentice Hall