Governance, Competition and Opportunistic Accounting Choices by Banks

• In Event: Financial Institutions and Discretionary Behaviour

Abstract

The ability of controlling owners to expropriate corporate resources represents a fundamental agency problem. Incentives to expropriate private benefits depend on a controlling shareholder’s skin-in-the-game as embedded in their holdings of cash-flow rights. Prior research shows that firm value falls both for banks and non-financial firms when the voting rights of controlling shareholders exceed their cash-flow rights. Controlling shareholders also have incentives to conceal expropriation activities from outsiders by opportunistically managing the firm’s accounting numbers. Utilizing a sample of 243 banks from 46 countries, we investigate whether earnings management in the form of loan loss provision smoothing increases as the wedge between control rights and cash-flow rights increases. Our main objective is to investigate the extent to which bank competition reduces agency costs. We test the hypothesis that disciplining pressure exerted on banks by intense bank competition counteracts negative consequences of the control rights-cash flow rights wedge, reducing incentives of controlling shareholders to engage in earnings smoothing. We find that the extent of earnings smoothing by banks is increasing in the magnitude of the wedge. We also find that the impact of the wedge on earnings smoothing significantly decreases as bank competition, measured using the Lerner index, increases. We contribute to the literature by showing the powerful role that competition plays in counteracting the negative consequences of weak governance structures as manifested in opportunistic accounting choices by banks.

Authors

• Qi (Susie) Wang, National University of Singapore

• Robert M Bushman, The University of North Carolina at Chapel Hill

• Christopher Williams, University of Michigan