Earnings management and equity incentives: evidence from the European banking industry
International Journal of Accounting & Information Management
ISSN: 1834-7649
Article publication date: 7 May 2019
Abstract
Purpose
This 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/approach
The 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.
Findings
The 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 implications
The 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/value
This 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.
Keywords
Acknowledgements
The authors declare no potential conflicts of interest with respect to the research, authorship, and/or publication of this article. There are no financial and personal relationships with other people or organisations that could inappropriately influence (bias) their work.
Declaration of conflicting interests: The authors declare no potential conflicts of interest with respect to the research, authorship and/or publication of this article. There are no financial and personal relationships with other people or organisations that could inappropriately influence (bias) their work.
Citation
Alhadab, M. and Al-Own, B. (2019), "Earnings management and equity incentives: evidence from the European banking industry", International Journal of Accounting & Information Management, Vol. 27 No. 2, pp. 244-261. https://doi.org/10.1108/IJAIM-08-2017-0094
Publisher
:Emerald Publishing Limited
Copyright © 2019, Emerald Publishing Limited