Bank earnings management and analyst coverage: evidence from loan loss provisions

Abstract

We investigate the role of loan loss provisions in analysts’ decision to follow banks. We find that abnormal loan loss provisions (ALLP), regardless of whether it is income-increasing or income-decreasing, reduce analyst coverage. We interpret this effect with the finding that the greater magnitude of ALLPs decreases the accuracy and increases the dispersion of analysts’ forecasts. In addition, the volatility in ALLPs leads to the decrease in analyst coverage as well. We also find a pecking order for lead analysts’ decisions in a noisy information environment. Lead analysts prefer to follow financial institutions with more accurate loan loss provisions first, then with more positive (incoming-decreasing) ALLPs, and are less likely to follow those with negative (income-increasing) ALLPs. Our findings are robust to endogeneity concerns and indicate that lead analysts are deterred from more aggressive bank earnings management.