مدیریت تعهدات خاص در مقابل ساختار معاملات: شواهدی از صنعت بانکداری

This study investigates earnings management through managing specific accruals vs. structuring transactions in the banking industry. This paper explores the circumstances under which banks manipulate loan loss provisions vs. circumstances that lead banks to structure loan sales and securitizations for the purpose of achieving earnings benchmarks. Empirical results show that banks manage earnings through loan loss provisions, before resorting to structuring transactions, to avoid small earnings decreases and or just meet or beat analysts' forecasts. The findings imply that structuring loan sales and securitizations is more likely to be used as a secondary instrument. In addition, I find that the earnings of banks with lower discretionary loan loss provisions and higher discretionary gains from loan sales and securitizations are priced more negatively, suggesting that investors impose incremental penalties on the joint use of loan loss provisions and gains from loan sales and securitization to meet or beat earnings benchmarks.

Existing literature has consistently documented evidence that companies manage earnings through manipulating specific accruals. Examples abound where companies adjust accounting estimates, such as bad debt expense (McNichols & Wilson, 1988), loan loss provisions in the banking industry (Beatty et al., 1995, Beatty et al., 2002 and Kanagaretnam et al., 2003), and insurance loss estimates in the insurance industry (Adiel, 1996 and Beaver et al., 2003), to manage earnings. Alternatively, companies can manipulate earnings through real activities manipulation (Roychowdhury, 2006). For example, companies structure issues of contingent convertible bond to manage diluted earnings per share (Marquardt & Wiedman, 2005). In addition, gains from securitizations have been used to manage earnings (Dechow et al., 2008, Karaoglu, 2005 and Niu and Richardson, 2004).1 A recent article in New York Times cites industry specialists who describe securitizations as “the thing about gain on sale accounting is that you can create a machine that just manufactures earnings out of thin air”. Although previous studies suggest that companies may have opportunities to influence earnings via the two available instruments – managing specific accruals and structuring transactions, no study to date has explicitly investigated how managers trade off real and accrual manipulations in a regulated industry – the banking industry. I fill this gap in the literature. Graham, Harvey, and Rajgopal (2005), Zang (2007), and Cohen and Zarowin (2010) examine the relation between accrual-based and real earnings management in non-banking sector.2 The motivations to manipulate earnings may differ in the regulated industry. For instance, bank regulators establish the minimum capital requirements and intervene in the operations of banks with inadequate capital (Beatty et al., 1995). Furthermore, banking companies provide a fertile ground for research to isolate the specific accruals from structuring transactions. Focusing on a single regulated industry enables me to better measure earnings management activities. This research design helps me compare the differential costs and benefits associated with each instrument, thus providing insight into how earnings management is achieved. Following prior research (Beatty et al., 1995 and Beatty et al., 2002), I use discretionary loan loss provisions as a proxy for managing specific accruals, given that loan loss provisions are a very important accrual for banks. Discretionary gains or losses (gains, hereinafter) from loan sales and securitizations are used as a proxy for structuring transactions at least for two reasons.3 First, managers have high level of judgment and discretion in reporting gains on loan sales and securitizations.4 Second, loan sales and securitizations are of particular interest, because they have expanded dramatically over the last decade. Securitizations give banks significant opportunities to affect accounting outcomes, as loans constitute over half of the balance sheet in commercial banks, and securities resulting from securitizations were the largest segment in debt market in 2005, totaling $7.4 trillion (Dechow et al., 2008).5 I build on previous research (Cohen and Zarowin, 2010 and Zang, 2007) by examining how and when bank managers use loan loss provisions and securitizations to manage reported earnings based on the respective costs and benefits. I argue managers' choice of each instrument is a function of the firms' ability to use the instrument and the costs of doing so. As compared to managing earnings through specific accruals, structuring transactions such as securitizations is more complex. Securitization is a timing consuming process and incurs higher direct costs. Therefore, managing earnings through accruals provides a cheaper way to influence financial statements. However, managing loss loan provisions has its own costs. A reduction on loan loss provisions increases reported earnings, but it may signal poor future prospects or even result in a violation of regulatory standards (Kanagaretnam et al., 2003). The conflicting directions arising from multiple objectives restrict the use of loan loss provisions. Managers are more likely to utilize loan loss provisions to meet earnings targets if the magnitude of earnings manipulation is close to the limit of loan loss provisions. This study I focus my attention on firms that slightly meet earnings targets, since these firms have a strong motivation to manage earnings. In particular, firms just meeting earnings targets have intrinsic earnings that are close to earnings targets (Lee, 2007) and therefore they have the ability to manage earnings by picking a cheaper instrument first. Consistent with the predictions, I find that banks use loan loss provisions, before resorting to structuring transactions, to avoid small earnings decreases and to just meet or beat analysts' forecasts. Specifically, gains from loan sales and securitizations are only used to manage earnings when pre-securitization earnings (i.e., earnings before the gain on loan sale and securitization) are lower than prior year's level and when pre-securitization earnings per share are less than analysts' forecasts. The findings of this study suggest that structuring transactions are more likely to be used in specific circumstances as a secondary tool. Additional analysis indicates that the results are robust after controlling for the simultaneity of discretion choices. The second part of this study is to examine how investors in the market react to earnings management when banks disclose loan loss provisions and loan sales and securitizations. Previous research (Niu and Richardson, 2004 and Wahlen, 1994) has examined the financial reporting consequences of these two instruments independent of each other. There is no evidence on how the joint use of these two instruments affects stock prices. A natural follow-up question is to investigate the incremental economic consequences of earnings management when both of these two instruments are used to meet earnings targets. Consistent with the hypotheses, I find that earnings with lower discretionary loan loss provisions and higher discretionary gains from loan sales and securitizations are priced more negatively. The results suggest that investors appear to recognize the tools for achieving earnings benchmarks and appropriately impose an incremental penalty when loan loss provisions and securitization gains are used simultaneously. In sum, this paper provides empirical evidence that investors may see through earnings management in the banking industry. A potential explanation is that, as a result of bank regulation, investors have access to extensive disclosures that are related to specific accruals and securitizations (Healy & Wahlen, 1999).6 This paper makes several contributions to the current literature. First, this study extends the literature by examining how managers use multiple tools to manage earnings. It is one of the first to investigate how managers trade off real vs. accrual management in banking industry. Investigation of management manipulation using specific accruals vs. structuring transactions is an extension of earnings management research. This extension is important because banks provide a natural setting to isolate loan loss provisions from loan sales and securitization gains, thus enabling me to develop more reliable measures of managerial discretion over earnings. The findings of this study help us understand the rationale for managers' choices of these instruments to avoid small earnings declines and to just meet or beat analysts' forecasts. Second, this paper adds to a growing body of research that documents the capital market consequences of earnings management. My results suggest that market participants punish firms to a greater extent when managing specific accruals and structuring transactions are used simultaneously. In this sense, the findings of this study have implications in making investment decisions. In addition, evidence on market efficiency with the joint use of these two instruments is likely to be of interest to standard setters.7 Finally, this paper presents evidence on how managers use the fair value accounting under SFAS140 to structure transactions in meeting earnings benchmarks, thus providing insights into the attributes that relate to the recent subprime crisis.8 The remainder of this paper is organized as follows. Section 2 reviews the literature and develops the hypotheses. Section 3 introduces the empirical models. Section 4 describes the samples. Section 5 presents the results, and Section 6 summarizes the paper.

This study examines the relationship between managing specific accruals and structuring transactions in meeting or beating earnings target and the financial reporting consequences when both of these two instruments are used. The objective of this study is to gain a better understanding of how managers use specific accruals and structure transactions to influence reported earnings. My results indicate that managers have a preference to pick the instruments. Specifically, managers use loan loss provisions to achieve earnings benchmarks without relying on gains from loan sales and securitizations. The findings suggest that banks manage loan loss provisions more pervasively than, and before, structuring loan sales and securitizations. In addition, I discover that earnings of banks reporting both lower discretionary loan loss provisions and higher discretionary gains from loan sales and securitizations are priced more negatively. The findings suggest that investors impose an incremental penalty when bank managers simultaneously manipulating specific accruals and structuring transactions. This study gives insight into the rationale for managers' choices of earnings management instruments. My results support the notion that mangers' choice of each instrument is a function of the firms' ability to use the instrument and the costs of doing so. This study adds to a stream of research that documents earnings management through managing special accruals and structuring transactions (Dechow et al., 2008, Karaoglu, 2005 and Niu and Richardson, 2004). Moreover, evidence from the market reaction to the joint use of these two instruments has implications in making investment decisions.