Earnings management, capital management, signalling and the Covid-19 pandemic: the case of listed banks in the United States

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. JEL Codes: M41, G21, C23, G28