Managerial Incentives and Earnings Management : An Empirical Examination of the Income Smoothing in the Nordic Banking Industry

Sammanfattning:

Prior empirical research, mainly conducted in US under the US GAAP, has indicated that managers in listed banks use loan loss provisions as a primary tool for income smoothing activities. Since 2005 the accounting environment in the European Union (EU) changed, as all listed companies are required to comply with International Financial Reporting Standards (IFRS). Some arguments envisage that IFRS is a set of high quality standards that plug some inconsistencies relative to national General Accepted Accounting Principles (GAAP). The overall objective of the present study is to examine earnings management and in particular income smoothing through the use of loan loss provisions (LLP) to manage earnings under IFRS and national GAAPs. The sample consists of twenty large commercial banks listed in the Nordic countries (Denmark, Finland, Norway and Sweden) for the years 2004-2012 (including early adopters) and sixteen banks for the years 1996-2003 under each country’s national reporting regime. Furthermore we present the body of earning management literature in conjunction with agency theory in order to grasp managers’ opportunistic behavior. Finally we assess the institutional role of financial reporting standards and the arguments of how IFRS could restrict earnings management activities as proposed by some authors. Overall, our results indicate some degree of income smoothing activities through loan loss provisions by bank managers both under national GAAPs and IFRS. The study contributes to the broad literature body on earnings management, while testing income-smoothing activities on a single industry compared to previous studies where the samples comprises a variety of firms in different industries.