Bank Earnings Management using Commission and Fee Income: the Role of Investor Protection and Economic Fluctuation

Ozili, Peterson K (2019): Bank Earnings Management using Commission and Fee Income: the Role of Investor Protection and Economic Fluctuation. Published in:

Abstract

We investigate whether banks use commission and fee income to manage reported earnings as an income-increasing or income smoothing strategy. We find that banks use commission and fee income for income smoothing purposes and this behaviour persist during recessionary periods and in environments with stronger investor protection. The implication of the findings is that bank non-interest income which achieves diversification gains to banks is also used to manipulate reported earnings. Our findings show that real earnings management is prevalent among banks in Africa. Further research into earnings management should examine real earnings management among non-financial firms in developing regions. From an accounting standard setting perspective, our evidence suggests the need for national/international standard setters to adopt strict revenue recognition rules that ensure that banks or firms report the actual fees they make, and to discourage banks from delaying (or deferring) the collection of fee income to manage or smooth reported earnings opportunistically.

• Item Type: MPRA Paper
• Language: English
• Keywords: Earnings management, Commission and Fee Income; Non-interest Income; Real Earnings Management; Income smoothing; Economic Condition; Investor Protection; Banks.
• Subjects: G - Financial Economics > G2 - Financial Institutions and Services; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M0 - General > M00 - General; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M1 - Business Administration; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M2 - Business Economics > M21 - Business Economics; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M41 - Accounting; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M42 - Auditing; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M48 - Government Policy and Regulation; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M49 - Other

References

Ahmed, A. S., Takeda, C., & Thomas, S. (1999), “Bank loan loss provisions: a reexamination of capital management, earnings management and signaling effects”, Journal of Accounting and Economics, Vol 28 No. 1, pp, 1-25.

Amidu, M. & Kuipo, R. (2015), “Earnings management, funding and diversification strategies of banks in Africa”, Accounting Research Journal, Vol 28 No 2, pp. 172-194.

Anandarajan, A., Hasan, I., & Lozano-Vivas, A. (2003), “The role of loan loss provisions in earnings management, capital management, and signaling: The Spanish experience”, Advances in International Accounting, 16, 45-65.

Arellano, M. & Bond, S. (1991), “Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations”, The Review of Economic Studies, Vol 58 No. 2, pp. 277-297.

Barth, M. E., Gómez Biscarri, J., Kasznik, R., & López-Espinosa, G. (2017), “Bank earnings and regulatory capital management using available for sale securities”. Review of Accounting Studies, Vol 22, No 4, 1761-1792.

Beatty, Anne L., Bin Ke, & Kathy R. Petroni. (2002), “Earnings Management to Avoid Earnings Declines across Publicly and Privately Held Banks”, The Accounting Review, Vol 77, No 3 pp. 547–570.

Beatty, A., & Liao, S. (2009), “Regulatory capital ratios, loan loss provisioning and procyclicality”, Columbus, United States: Ohio State University. Mimeographed document.

Beck, T., De Jonghe, O. & Schepens, G. (2013), “Bank competition and stability: cross-country heterogeneity” Journal of Financial Intermediation, Vol 22 No. 2, pp. 218-244.

Beck, T., & Cull, R. (2013) “Banking in Africa.” World Bank Policy Research Working Paper, No. 6684.

Beneish, M. D. (2001) “Earnings management: A perspective. Managerial Finance, Vol 27 No. 12, pp. 3-17.

Bens, D. A., Nagar, V., & Wong, M. H. (2002) “Real investment implications of employee stock option exercises”, Journal of Accounting Research, Vol 40 No. 2, pp. 359-393.

Bernard, V. L., & Skinner, D. J. (1996), “What motivates managers' choice of discretionary accruals?” Journal of Accounting and Economics, Vol. 22 No. 1, pp. 313-325.

Bushman, R. M., & Williams, C. D. (2012), “Accounting discretion, loan loss provisioning, and discipline of banks’ risk-taking”. Journal of Accounting and Economics, Vol 54 No.1, pp. 1-18.

Caylor, M. L (2010), “Strategic revenue recognition to achieve earnings benchmarks”, Journal of Accounting and Public Policy, Vol 29 No.1, pp. 82-95.

Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1995), “Detecting earnings management”, The Accounting Review, Vol 70 No 2, pp. 193-225.

Dechow, P., & R. Sloan. (1991), “Executive incentives and the horizon problem: An empirical investigation”, Journal of Accounting and Economics, Vol 14 No.1, pp. 51–89.

DeYoung, R., & Rice, T. (2004), “How do banks make money? The fallacies of fee income”, Economic Perspectives - Federal Reserve Bank of Chicago, Vol. 28 No.4, pp. 34.

DeYoung, R., & Roland, K. P. (2001), “Product mix and earnings volatility at commercial banks: Evidence from a degree of total leverage model”, Journal of Financial Intermediation, Vol 10 No 1, pp. 54-84.

El Sood, H. A. (2012) “Loan loss provisions and income smoothing in US banks pre and post the financial crisis”, International Review of Financial Analysis, Vol 25, pp. 64-72.

Fonseca, A. R. & González, F. (2008), “Cross-country determinants of bank income smoothing by managing loan-loss provisions”, Journal of Banking and Finance, Vol 32 No 2, pp. 217-228.

Greenawalt, M. B., & Sinkey, J. F. (1988). Bank loan-loss provisions and the income-smoothing hypothesis: an empirical analysis, 1976–1984. Journal of financial services research, Vol 1 No 4, pp. 301-318.

Hamdi, M. & Zarai, M. (2012), “Earnings Management to Avoid Earnings Decreases and Losses:Empirical Evidence from Islamic Banking Industry”, Research Journal of Finance and Accounting. Vol 3 No.3, pp. 88.

Jones, J. (1991), “Earnings management during import relief investigations”, Journal of Accounting Research, Vol. 29, No 2, pp.193-228.

Kothari, S. P. (2001), “Capital markets research in accounting”, Journal of Accounting and Economics, Vol. 31 No. 1, pp. 105-231.

Leuz, C., Nanda, D., & Wysocki, P. D. (2003). Earnings management and investor protection: an international comparison. Journal of financial economics, Vol. 69 No.3, pp. 505-527.

Liu, C. C., & Ryan, S. G. (2006), “Income smoothing over the business cycle: Changes in banks' coordinated management of provisions for loan losses and loan charge-offs from the pre-1990 bust to the 1990s boom”, The Accounting Review, Vol 81 No.2, pp. 421-441.

McNichols, M. F. (2001), “Research design issues in earnings management studies”, Journal of accounting and public policy, Vol. 19 No.4, pp. 313-345.

McNichols, M., & Wilson, G. P. (1988), “Evidence of earnings management from the provision for bad debts”, Journal of Accounting Research, Vol 26, pp.1-31.

Ozili, P. K. (2015), “Loan Loss Provisioning, Income Smoothing, Signaling, Capital Management and Procyclicality: Does IFRS Matter? Empirical Evidence from Nigeria”, Mediterranean Journal of Social Sciences, Vol 6 No.2, pp. 224-232.

Ozili P. K. (2017a), “Bank Earnings Management and Income Smoothing using Commission and Fee Income: A European Context”, International Journal of Managerial Finance, Vol 13, No 4, pp. 419-439.

Ozili P. K. (2017b), “Bank earnings smoothing, audit quality and procyclicality in Africa: The case of loan loss provisions”, Review of Accounting and Finance, Vol 16 No 2, pp 142-161.

Ozili P. K. and Thankom, A. G. (2018), “Income Smoothing among European systemic and non-systemic banks.” British Accounting Review, Vol 50, No 5, 539-558.

Ozili, P. K., & Outa, E. (2017). Bank loan loss provisions research: A review. Borsa Istanbul Review. Vol 17, No 3, 144-163.

Ozili, P. K. (2018a). Bank loan loss provisions, investor protection and the macroeconomy. International Journal of Emerging Markets, 13(1), 45-65.

Ozili, P. K., & Outa, E. R. (2018). Bank earnings smoothing during mandatory IFRS adoption in Nigeria. African Journal of Economic and Management Studies.

Petersen, M. (2009), “Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches”, Review of Financial Studies, Vol 22, No 1 pp. 435-448.

Plummer, E., & D. Mest. (2001), “Evidence on the management of earnings components”, Journal of Accounting, Auditing & Finance, Vol 16, No 4, pp 301–323.

Roychowdhury,S. (2006). “Earnings management through real activities manipulation”, Journal of Accounting and Economics, Vol 42, No 3 pp. 335-370

Smith, R., Staikouras, C. & Wood, G. (2003), “Non-interest income and total income stability”, Bank of England Working Paper No 198. Available at: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/2003/wp198.pdf (Accessed: 4th January, 2016).

Stiroh, K. (2004), “Diversification in banking: Is non-interest income the answer?” Journal of Money, Credit and Banking, Vol. 36, No 5 pp. 853-882.

Stiroh, K. J. & Rumble, A. (2006), “The dark side of diversification: The case of US financial holding companies”, Journal of Banking & Finance, Vol 30, No.8, pp. 2131-2161.

Stubben, S. R. (2010), “Discretionary revenues as a measure of earnings management”. The Accounting Review, Vol. 85 No. 2, pp. 695-717.

Thomas, J., & Zhang X. J. (2000), “Identifying unexpected accruals: a comparison of current approaches”. Journal of Accounting and Public Policy, Vol. 19, No 4-5, pp.347-376.

Watts, R. L., & Zimmerman, J. L. (1986), Positive accounting theory. Prentice-Hall, New Jersey.

Zang, A. Y. (2011), “Evidence on the trade-off between real activities manipulation and accrual-based earnings management”. The Accounting Review, Vol. 87 No. 2, pp. 675-703.