Regulatory and Contextual Determinants of Earnings and Capital Management: Empirical Evidence from European-Listed Banks

• In Event: Financial Reporting Quality

Abstract

Purpose. The aim of this paper is investigating the effects of regulatory and contextual features on earnings and capital management in the European banking sector.
Methodology. To investigate whether regulatory and contextual variables can exert an impact on earnings and capital management through discretionary loan loss provisions (LLPs), this paper estimates non-discretionary LLPs as residuals of LLPs regression and then, using another OLS regression, it verifies the impact of the above-mentioned proxies on earnings and capital manipulations.
Findings. The study shows that in the European banking sector, the financial crisis and competition created intense pressure for disclosing (un)real better economic performance and higher patrimonial solidity, damaging the quality of earnings and regulatory capital through manipulations. Moreover, the adjustment process to new IFRS 9 standard did not favor safer accounting practices, but it advanced the recourse to capital manipulations.
Implications. This study can best benefit accounting standards setters to improve the reliability of financial disclosure, banking sector EU-regulators to set operations of adjustment to new capital restrictions, market authorities to intervene in competition regulation settings, and stakeholders to recognize accounting manipulation red flags.
Originality/value. This is the first study that investigates the European banking sector and seeks to understand whether the new regulation factors, such as the strengthening of prudence in detecting loan losses (IFRS 9) and the reinforcement of minimum regulatory capital constraints (Basel III), together with two particular contextual features, such as the financial crisis and competition, have effectively favored safer accounting practices and improved transparency of financial statements or conversely have caused accounting manipulations to confound market participants’ expectations and receive positive evaluation from banking supervisory authorities.

Authors

• Adele Caldarelli, University of Naples Federico II

• Raffaela Casciello, University of Naples Federico II

• Marco Maffei, University of Naples Federico II