Does the business model influence income smoothing? Evidence from European banks

Abstract

PurposeThe purpose of this paper is to explore whether the business model (BM) influences bank income smoothing by considering two competing perspectives, the opportunistic and the information enhancement one. Additionally, the paper addresses the role of auditors’ involvement in national supervision and external governance.Design/methodology/approachIncome smoothing is measured by regressing loan loss provisions on unmanaged earnings, and the moderating role of country-level factors is tested employing three-way interactions. The sample consists of European banks observed from 2004 to 2015.FindingsResults indicate that the BM affects smoothing and that retail-funded banks exhibit smoother earnings due to informative reasons. National supervisors’ emphasis on audit is positively associated with smoothing by market-oriented banks, whereas external governance constrains smoothing in diversified-retail banks.Research limitations/implicationsEuropean reforms strengthening monitoring bodies could bring the unintended effect of inducing opportunistic behaviours in market-oriented BMs. However, this study employs indirect proxies for institutional factors and does not consider internal-governance issues.Practical implicationsEvidence sustains the IASB choice of the expected-loss approach for estimating credit losses as it could enhance the informativeness of retail-funded banks’ accounting numbers.Originality/valueThis paper contributes to the income smoothing literature by addressing the role of the BM as a whole in explaining smoothing propensity, not limiting the observation to partial features of the balance sheet. Moreover, it supports a counterintuitive argument, thepenalty hypothesis, assuming that stronger supervision increases bank incentives to manage earnings to avoid penalties.