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Earnings management and equity incentives: evidence from the European banking industry

Earnings management and equity incentives: evidence from the European banking industry PurposeThis study aims to examine the effect of equity incentives on earnings management that occurs via the use of loan loss provisions by using a sample of 204 bank-year observations over the period 2006-2011.Design/methodology/approachThe authors use the data of 39 European banks to test the main hypothesis. Several valuation models and regressions are used to measure the main proxies for executives’ compensation and the determinant factors of loan loss provisions.FindingsThe empirical results reveal that earnings management that occurs via discretionary loan loss provisions is associated with equity incentives in the banking industry. In particular, European banks’ executives with high equity incentives are found to manage reported earnings upwards by reducing loan loss provisions. The results therefore show that income-increasing earnings management via discretionary loan loss provisions is widely practised by the executives of European banks and that this is partly motivated by executives’ compensation.Practical implicationsThe findings of this paper present important implications for regulators in the European Union, who should take further steps to reform the regulatory environment to monitor and mitigate the earnings management practices that occur via the manipulation of loan loss provisions. Earnings management practices do not just negatively affect subsequent performance but are also found to lead to firms’ failure. Thus, regulators should take the necessary reforms to protect the wealth of stakeholders (investors, creditors, etc.).Originality/valueThis study provides the first evidence on the relationship between equity incentives and earnings management in the European banking industry. The study sheds more light on an issue of great interest to a broad audience that does not receive much attention in the prior research, thus opening new avenues for future research. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png International Journal of Accounting and Information Management Emerald Publishing

Earnings management and equity incentives: evidence from the European banking industry

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
1834-7649
DOI
10.1108/IJAIM-08-2017-0094
Publisher site
See Article on Publisher Site

Abstract

PurposeThis study aims to examine the effect of equity incentives on earnings management that occurs via the use of loan loss provisions by using a sample of 204 bank-year observations over the period 2006-2011.Design/methodology/approachThe authors use the data of 39 European banks to test the main hypothesis. Several valuation models and regressions are used to measure the main proxies for executives’ compensation and the determinant factors of loan loss provisions.FindingsThe empirical results reveal that earnings management that occurs via discretionary loan loss provisions is associated with equity incentives in the banking industry. In particular, European banks’ executives with high equity incentives are found to manage reported earnings upwards by reducing loan loss provisions. The results therefore show that income-increasing earnings management via discretionary loan loss provisions is widely practised by the executives of European banks and that this is partly motivated by executives’ compensation.Practical implicationsThe findings of this paper present important implications for regulators in the European Union, who should take further steps to reform the regulatory environment to monitor and mitigate the earnings management practices that occur via the manipulation of loan loss provisions. Earnings management practices do not just negatively affect subsequent performance but are also found to lead to firms’ failure. Thus, regulators should take the necessary reforms to protect the wealth of stakeholders (investors, creditors, etc.).Originality/valueThis study provides the first evidence on the relationship between equity incentives and earnings management in the European banking industry. The study sheds more light on an issue of great interest to a broad audience that does not receive much attention in the prior research, thus opening new avenues for future research.

Journal

International Journal of Accounting and Information ManagementEmerald Publishing

Published: May 7, 2019

References