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Market-Based Solutions to Vital Economic Issues

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Market-Based Solutions to Vital Economic Issues
Research
Apr 1, 2017

Governance, Competition and Opportunistic Accounting Choices by Banks

Abstract

We investigate the influence of bank competition on agency costs by examining whether
earnings management in the form of loan loss provision smoothing increases as the wedge between control rights and cash-flow rights increases. We hypothesize that disciplining pressure from intense bank competition counteracts negative consequences of a control rights-cash flow rights wedge, reducing incentives of controlling shareholders to engage in earnings smoothing. While we find that earnings smoothing by banks is increasing in the magnitude of the wedge, the impact of the wedge on earnings smoothing significantly decreases as bank competition increases. Our results illustrate the powerful role that competition can play in counteracting negative consequences of weak governance structures for opportunistic accounting choices by banks.


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