The influence of accounting enforcement on earnings quality of banks: Implications of bank regulation and the global financial crisis

• Published in: Journal of accounting and public policy Vol. 37; no. 5; pp. 402 - 419
• Main Authors: Dal Maso, Lorenzo, Kanagaretnam, Kiridaran, Lobo, Gerald J., Terzani, Simone
• Format: Journal Article
• Language: English
• Published: New York Elsevier Inc 01.09.2018; Elsevier Sequoia S.A
• Subjects: Accounting; Accounting enforcement; Accounting standards; Bank earnings; Bank regulation; Banking industry; Banking law; Earnings; Earnings benchmarks; Earnings management; Earnings quality; Economic crisis; Enforcement; Global financial crisis; International finance; Loan loss allowances; Loan loss provisions; Regulation of financial institutions; Bank regulation; Earnings benchmarks; Loan loss provisions; Accounting enforcement; Global financial crisis; Earnings quality
• ISSN: 0278-4254; 1873-2070
• DOI: 10.1016/j.jaccpubpol.2018.09.003

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.