Abstract
We study the effects of country-level accounting enforcement on earnings quality of banks and whether bank regulation substitutes or complements the effect of accounting enforcement on bank earnings quality. We also examine whether the influence of accounting enforcement on bank earnings quality changed after the global financial crisis. Using a sample of listed banks from 40 countries between 2001 and 2014, and abnormal loan loss provisions (ALLP) as our main proxy for earnings quality, we document a consistent and strong association between accounting enforcement and bank earnings quality. More specifically, an increase in accounting enforcement decreases the level of ALLP and decreases the propensity to manage earnings to avoid losses. Furthermore, we provide empirical evidence that bank regulation complements the effect of accounting enforcement on bank earnings quality. Finally, unlike in the pre-crisis period, we find a positive association between accounting enforcement and income-decreasing ALLP in the post-crisis period, which indicates that stronger accounting enforcement is associated with more conservative earnings and higher loan loss reserves. Overall, our results indicate that accounting enforcement reduces opportunistic earnings management.
1. Introduction
We investigate the relation between country-level accounting enforcement and earnings quality of banks for a sample of publiclylisted international banks. We first examine how accounting enforcement by itself relates to bank earnings quality and then we examine the implications of bank regulation for the accounting enforcement-earnings quality relation. We also study whether the effect of accounting enforcement on earnings management changed after the global financial crisis.
6. Conclusion
We study the effects of country-level accounting enforcement on earnings quality of listed banks and whether bank regulation substitutes or complements the effect of accounting enforcement on bank earnings quality. We use the absolute value of abnormal loan loss provisions (ALLP), income-increasing ALLP, and income-decreasing ALLP, and the extent of earnings management to avoid a loss to test the impact of accounting enforcement on earnings quality. We employ a sample of listed banks from the BankScope database representing 40 countries between 2001 and 2014 to test our predictions. We examine three questions. First, we examine whether accounting enforcement enhances the earnings quality of banks. Second, we examine whether bank regulation complements or substitutes the effect of accounting enforcement on earnings quality. Third, we examine whether the influence of accounting enforcement on bank earnings quality has changed after the financial crisis.
