Discretionary loan loss provision behavior in the US banking industry

Abstract

Earnings management can be opportunistic and add noise to earnings, or informative about a firm’s underlying economic performance and add information to financial reports. Our study examines earnings management in banks with different levels of information asymmetry. We compare earnings management between public and private banks by using discretionary loan loss provisions (DLLPs) as a proxy. We use a dataset of US public and private banks from 1986:Q1 to 2013:Q4 and provide evidence of greater earnings management in public banks than private banks. We also examine the conditions that motivate managers to engage in earnings management. DLLPs are used to send private information to investors, consistent with our signaling hypothesis. We also find evidence that capital requirements alter DLLPs, consistent with our capital management hypothesis. Banks with relatively low (high) earnings tend to decrease (increase) their earnings through manipulation of DLLPs, inconsistent with our income-smoothing hypothesis. This study extends the current literature on earnings management between public and private banks. Our discussion provides a better understanding of the determinants of bank earnings management.