Financial Statement Comparability, Earnings Smoothing and Loan-Loss Provisioning in Banking

Abstract

We investigate the effect of financial statement comparability on banks’ earnings smoothing behavior through loan-loss provisioning. Financial statement comparability makes information about peers accessible to outside investors and, thereby, improves transparency and the information environment. We, therefore, predict a negative association between financial statement comparability and earnings smoothing for opportunistic reasons. Based on a sample of 628 US banks (4,683 bank-years observations) for the period 1999-2013, we show that financial statement comparability constrains income smoothing through loan-loss provisioning. We further reveal that this constraining effect is more pronounced for larger banks and during the global financial crisis (GFC) period. These results are robust to alternative specifications of comparability and earning management, bank (firm) fixed effect regression, and also dealing with endogeneity issues. We contribute to the literature on the benefits of producing comparable financial statements, as well as to the literature on the determinants of earnings smoothing by banks. Our results are also relevant for standard setters who stress the importance of financial statement comparability for nurturing investor confidence.