The influence of IFRS on earnings management

Effective 2005 all listed companies in the European Union ( EU ) are required to follow with IFRS. The inquiries we address are: first and chiefly, whether IFRS has an impact on net incomes direction behavior with particular accent on Bankss in the EU ; 2nd, whether IFRS influences behaviour comparative to capital direction for EU Bankss We use a sample of 91 Bankss in 18 European states covering a period of 10 old ages ( before and after execution of IFRS ) . Overall, we find that net incomes and capital direction behavior by bank directors has non significantly changed after acceptance of IFRS. This is contrary to the theory which assumes net incomes direction in peculiar should be significantly mitigated because IFRS bounds accounting picks therefore restricting timeserving behavior. It may be that execution is slack. We besides find that, for hazardous Bankss in peculiar, net incomes direction behavior is more marked in the station IFRS period.

Cardinal words: Net incomes direction, capital direction, IFRS, European Union.

The Influence of IFRS on Earnings Management and Capital Management Practices of Banks in the European Union


Effective 2005 all listed companies in the European Union ( EU ) are required to follow with IFRS. The inquiries we address are: first and chiefly, whether IFRS alterations net incomes direction behavior with particular accent on Bankss in the EU ; 2nd, whether IFRS influences behaviour comparative to capital direction for EU Bankss. In peculiar we examine if the execution of IFRS reduced net incomes direction and direction of capital to avoid misdemeanor of capital adequateness ratios.

The primary motive for this survey is to foster our apprehension of the influence of IFRS on quality of reported net incomes. Overall, IFRS are rule based criterions that are market oriented and require extended revelation relation to prior criterions i.e. , local by and large accepted accounting rules ( GAAP ) . The International Accounting Standards Board ( IASB ) removed allowable accounting options ( that existed in most states under their several GAAPs ) and require accounting measurings that better reflect a house ‘s economic place and public presentation. In kernel, IFRS are precise, admit a really limited figure of options, and prohibit concealed militias. Based on this, in theory, the acceptance of IFRS should significantly cut down the ability to prosecute in net incomes direction behavior. IFRS limits the chance of direction to prosecute in timeserving behavior by restricting the accounting options available to them. However, Barth et Al. ( 2008 ) note that the converse could besides be true. For illustration, restricting managerial discretion associating to accounting options could extinguish a house ‘s ability to describe accounting measurings that are more brooding of the house ‘s economic place and public presentation. They besides note that if enforcement of these criterions are slack, companies could still prosecute in net incomes direction. Presently, in the literature, there are two opposing positions on the influence of IFRS. On the one side research workers argue that IFRS improves the dependability of fiscal coverage by restricting timeserving managerial discretion ( Barth et al. 2008 ; Ewert and Wagenhofer 2005 ; Ashbaugh and Pincus 2001. ) The contrary position is that the flexibleness inherent in IFRSs and slack enforcement might supply greater chance for houses to pull off net incomes ( Burgstahler et al. 2006 ; Ball et al. 2003 ; Street and Gray 2001 ; Cairns 1999 ; Breeden 1994 ; among others. ) Part of the motive of this survey is to cast farther visible radiation on the viing theories with respect to the efficaciousness of IFRS in cut downing net incomes direction and bettering net incomes quality.

While two conflicting theories exist on the influence of IFRS as noted above, research on the influence of IFRS on net incomes direction has provided assorted consequences. Van Tendeloo and Vanstraelen ( 2005 ) for illustration, found that net incomes direction behavior was non significantly different between companies in Germany that adopted IFRS and those that did non follow and trust on German GAAP. However, these findings are refuted by Barth et Al. ( 2008 ) who, utilizing a sample of 21 states, concluded that in the station acceptance period, houses using IFRS displayed significantly less net incomes direction relation to the pre-adoption period. These are the lone two published surveies analyzing the influence of IFRS on net incomes direction. These two surveies used informations consisting different non-financial industries ( Barth et al, in peculiar straddling 21 states ) While they use heterogeneous informations in that they include a assortment of industries in their sample, we contribute to the extant literature by utilizing homogeneous informations. Our sample comprises fiscal establishments in the signifier of commercial Bankss merely. We felt that the consequences would be more meaningful if we focused on one particular industry merely.

Our sample comprises 91 listed commercial Bankss arising from 18 European states covering a 10 twelvemonth period. We compared net incomes direction behaviour prior to and after following IFRS criterions. Most anterior research tells us that the primary tool for pull offing net incomes by commercial Bankss is loan loss commissariats ( Anandarajan et al. 2003 ; Ahmed et Al. 1998 ; Kim and Kross 1998 ; Liu et Al. 1997 ; Collins et Al. 1995 ; Beatty et Al. 1995 ; Moyer 1990 ; Greenawalt and Sinkey 1988 ; among others. ) In peculiar, IFRS in IAS No. 39 provide counsel on how loan loss commissariats should be established and limits the ability of directors to exert flexibleness in finding the proviso. If the ability to utilize LLPs to pull off net incomes are limited so we should grounds lower net incomes direction station IFRS. Since net incomes direction and capital adequateness ratios are per se linked harmonizing to these surveies, we besides examine the influence of IFRS on capital direction. After commanding for the macro-economic conditions in each state of our sample and bank size we find that the acceptance of IFRS has non significantly changed net incomes direction behavior ( i.e. , net incomes direction is non significantly lower in the station IFRS period ) . However, hazardous Bankss in our sample engaged in comparatively greater net incomes direction in the station IFRS period. We besides find that LLPs are non used to pull off capital to avoid capital adequateness ratios in the station IFRS period.

In the following subdivision we discuss the regulative environment in the European Union with peculiar mention to loan loss commissariats. Section 2 discusses briefly the regulative environment in European banking. In subdivision 3 we discuss relevant literature and develop our hypothesis. Section 4 trades with our research methodological analysis. Section 5 nowadayss the consequences and the concluding subdivision provides our decisions.

Regulatory Environment of European Banking

Bank accounting in Europe ab initio varied by state ( World Bank 2003 ) . The definitions of what should consist regulative capital besides varied by state with each state ‘s regulative organic structure puting their ain respective degrees and criterions. In order to get the better of this and to ease reading of banking public presentation across states, the Basel commission issued two agreements. Basel 1 introduced minimal capital demands ( Tier 1 and Tier II ) . The demands of this agreement later extended to more than a 100 states worldwide. Basel 1 unwittingly created loopholes which, harmonizing to research workers, enabled Bankss to prosecute in more aggressive net incomes direction. Prior to Basel 1 if a bank attempted to cut down loan loss militias to increase net incomes, it adversely affected the capital adequateness ratio since loan loss militias were portion of the numerator of the capital adequateness ratio. However, Basel 1 limited loan loss militias in the numerator of the capital adequateness to 1.25 % of hazard weighted assets. Since this was non a important constituent of the numerator Bankss could cut down loan loss militias without significantly deteriorating the capital adequateness ratio. Research workers concluded that this encouraged directors to prosecute in more net incomes direction. Basel II ab initio published in June 2004, adopted by the EU in 2005 was implemented at the beginning of June 2006. The range of Base II was to make an international criterion to guard against operational and fiscal hazard and protect the international fiscal system from bank solvency. While the agreement did non alter the construction of the capital adequateness ration with respect to the sum of loan loss militias in the numerator, it required Bankss to separate loans into classs harmonizing to the chance of default. The intent was to cut down discretional judgement by bank directors ( BIS 2005 ) .

EU Bankss were required to follow IFRS in December 2005. Loan loss commissariats were regulated by IAS No. 39. This made certain alterations relative to loan loss militias, viz. :

Certain assets were required to be classified as investings under IFRS without loan loss commissariats.

No general commissariats allowed. ( Earlier bank directors could do a “ general ” proviso to loan loss modesty without placing possible default clients. )

LLPs to be determined based on an incurred loss theoretical account supported by nonsubjective grounds of damage ( either due to a individual loss event or a group of events ) . This was similar to the classification required by Basel II agreement.

LLPs can non reflect losingss based on expected future events ( which was allowed antecedently ) .

These alterations, viz. , cut downing the degree of discretion to directors ( by extinguishing “ general ” commissariats and necessitating them to do a determination supported by nonsubjective grounds of damage ) would, it was expected, replace subjective judgements with nonsubjective judgements and cut down the ability of directors to pull strings loan loss militias ( and therefore extenuate the possibility of net incomes direction ) . However, no survey to day of the month has tested whether net incomes direction is so mitigated.

We now discuss relevant anterior literature and develop our hypotheses.

Literature Review and Hypotheses Development

LLPs and Earnings Management

The banking industry has been characterized as more prone to net incomes use when compared to other states ( Greenawalt and Sinkey 1988 ) . The seminal paper by Scheiner ( 1981 ) examined a sample of US commercial Bankss and concluded that LLPs are an of import tool used by bank directors for pull offing net incomes. Ma ( 1988 ) and Greenawalt and Sinkey ( 1988 ) provided grounds that bank directors tend to raise LLPs in periods of high runing income in order to lower volatility of reported net incomes. This is supported by many surveies concentrating on US Bankss ( Healy and Wahlen 1999 ; Ahmed et Al. 1998 ; Liu et Al. 1997 ; Beaver and Engel 1996 ; Liu and Ryan 1995 ; Collins et Al. 1995 ; Scholes et Al. 1990 ; among others ) . All these surveies concluded that, in the US particularly, LLPs are used by Bankss as a mechanism for aggressive net incomes direction, chiefly for stock market intents. Studies utilizing non-US Bankss besides arrive at similar decisions ( Anandarajan et al 2003, 2007 ; Perez et Al. 2008 ) .

Therefore we hypothesize that:

H1a: Loan loss commissariats will be positively associated with net incomes

A end of the IASB is to develop an internationally acceptable set of high quality fiscal coverage criterions ( IASB, 2009 ) . To accomplish this end, the IASB, as antecedently mentioned, adopted principles-based criterions, removed alternate accounting interventions and encouraged more strict enforcement. Empirical grounds suggests that restricting timeserving discretion additions quality of reported net incomes ( Ewert and Wagenhofer 2005 ; Ashbaugh and Pincus 2001 ) . Armstrong et Al ( 2009 ) happen a positive market reaction for EU companies, peculiarly Bankss, after acceptance of IFRS. Stock market investors seemingly view the acceptance of IFRS as bettering net incomes quality in the presence of decreased managerial discretion and reacted consequently. Barth et Al ( 2008 ) utilizing a sample of 21 states reported grounds that companies following IFRS reduced net incomes direction. Therefore, we hypothesize:

H1b. The relation between LLPs and net incomes ( before loan loss proviso ) will be less positive in the station IFRS government.

Banks confronting increased degrees of solvency hazard could hold an inducement to pull off net incomes in order to avoid costs related to regulative intercession. Yasuda et Al ( 2004 ) supply grounds that troubled Bankss prosecute in inordinate window dressing in net incomes and increase bad loans. Bhat ( 1996 ) finds a important association between hapless fiscal wellness and Bankss prosecuting in inordinate net incomes direction. Therefore, Bankss confronting a higher chance of insolvency may hold greater inducements for utilizing LLPs to pull strings reported accounting Numberss. However, IFRS, in theory, should cut down the ability of bank directors to prosecute in net incomes direction. We therefore hypothesize:

H1c. The relation between LLPs and net incomes ( before loan loss proviso ) will be comparatively less positive for riskier Bankss in the station IFRS government

LLPs and Capital Management

In this paper we besides examine whether the IFRS has influenced capital direction by the Bankss in our sample. The usage of LLPs to pull strings the capital adequateness ratio has been documented by anterior research ( Collins et Al. 1995 ; Beatty et Al. 1995 ; Scholes et Al. 1990 ; Moyer 1990 ) . The inducement for pull stringsing the capital adequateness ratio arises because misdemeanor of this ratio will incur regulative costs ( Anandarajan et al. 2003 ) . The consequences in the research are non conclusive. Some surveies report grounds of a negative association between LLPs and capital ratios verifying the being of capital direction behavior ( Beatty et al. 1995 ; Scholes et Al 1990 ) . However, Collins et Al ( 1995 ) found on grounds of capital direction behavior. However, these surveies used informations prior to the Basel 1 agreement. Kim and Kross ( 1998 ) and Ahmed et Al ( 1998 ) examined whether LLPs were used to pull off capital adequateness ratios after the execution of the Basel 1 agreement and found grounds demoing being of capital direction utilizing LLPs. Wall and Koch ( which one? ? ) in a later survey besides corroborated the findings of Ahmed et al. , and Kim and Kross. These surveies used US Bankss. In surveies utilizing Bankss from other industrialised states, Anandarajan et Al ( 2003 and 2007 ) and Perez et Al ( 2008 ) found no grounds for Australian and Spanish banking sectors. Hence, overall, the consequences appear to be conclusive that Bankss, particularly after the execution of Basel Accord 1 do non prosecute in capital direction behavior utilizing LLPs due to the limitations imposed by the Accord. However, motives for capital direction still be and might be a strong inducement for Bankss which face higher costs of go againsting capital demands ( Anandarajan et al. 2003 ) . Consequently we hypothesize that Bankss with comparatively higher costs of go againsting minimal capital demands will prosecute in more capital direction. Our hypothesis is stated as follows:

H2a: The higher the cost of capital adequateness misdemeanor, the greater the leaning for Bankss to pull off capital utilizing LLPs.

European companies before the acceptance of IFRSs had merely really general EU counsel on loan loss provisioning ( Laurin and Majnoni, 2003 ) . Therefore, Bankss relied on state specific accounting ordinances and supervisory guidelines in measuring probationary degrees. National revenue enhancement deductibility of loan losingss provided a strong inducement to EU Bankss to either set aside equal loan loss commissariats or to put commissariats relative to revenue enhancement acceptable degrees in order to derive on revenue enhancement deductibility but retain capital adequateness. The Basel Committee requires Bankss to utilize accounting rules reflecting prudent and conservative rating in their loan loss provisioning determinations ( Hasan and Wall, 2004 ) . European Bankss have applied the Fourth Directive under which Bankss operate under accrual accounting irrespective the timing of hard currency flows. However, accumulations might hold been applied more or less prudential based on a multiset of factors across different EU Bankss. Banks runing under IFRSs need to find specific and general allowances of loan losingss. Specific allowances are determined in single instances when possible degree. General allowances are determined based on historical experience and current conditions bespeaking damage of loans ( Epstein and Jermakowich, 2007 ) .

The acceptance of IFRSs by EU member states influenced measuring and revelation patterns on several facets by presenting a more rigorous definition of equity on several evidences: 1 ) EU Bankss are obliged to sort similar fiscal instruments into common classs and unwrap information relevant to their significance, nature and hazards ( Epstein and Jermakowich, 2007 ) . Asset values and hazard are linked with economic capital and entities are obliged to show informations about exposure to several banking hazards. 2 ) IFRSs imposed specific preferable portions and intercrossed instruments antecedently classified as equity ( and included in Tier 1 capital ) to be classified as liabilities which significantly affected the regulative capital ( APRA, 2005 ) . Taken together, we expect that specific ordinances and restricted equity might cut down discretional direction. Consequently, the 2nd portion of our 2nd hypothesis provinces:

H2b. The relation between LLPs and capital adequateness ratio will be more positive in the post-IFRS period relation to the pre-IFRS period.

Finally, we consider the impact of solvency hazard as an of import factor which drives managerial determinations on capital direction. Solvency hazard indicates bankruptcy chance. From a finance position, Bankss hold capital sums in order to decide bureau struggles between stockholders, depositors, creditors and sureties. Under this model, equity capital provides confidences appropriate hazard degrees. Relatively, bank capital provides the assurance factor to depositors and creditors which in bend determine the stableness of the bank and the stableness of the fiscal system in entire ( Anderson and Fraser, 2000 ) . Likewise, the bank ‘s net worth and the stableness of net incomes ( presuming unvarying revelation of quality information ) are of import to market assurance. Since, it is common to see bank capital as a shock absorber to absorb unexpected losingss originating from recognition hazard, involvement rate hazard and liquidness hazard, Bankss capital is a critical component for bring forthing assurance about bank ‘s ability to manage uncertainness. This fact suggests an opposite relationship between the degree of bank capital and hazard exposure ( Boyd et. Al, 1993 ; Shrieves and Dahl, 2003 ; Yasuda et. Al, 2004 ) . Consequently, we expect bank directors who face low degrees of solvency hazard to hold fewer inducements for dissembling the bank ‘s capital. Therefore, we hypothesise:

H2c. More hazardous Bankss will hold a greater inducement to pull strings capital via LLPs than less hazardous Bankss.

4. Data & A ; Methodology

4.1 Data & A ; Sample Selection

The dataset used in our survey is limited to EU listed commercial Bankss for a ten-year period ( 1999-2008 ) . During the specific clip frame the commercial Bankss were capable to two major regulative alterations: The compulsory acceptance of IFRS on January 2005 and the execution of the Basel II Accord on December 2006. Data were extracted from Thomson 1 Banker database and carefully reviewed for any information incompatibilities and handiness. Commercial Bankss with uncomplete informations, cardinal Bankss, authorities development Bankss, concerted Bankss and export-import Bankss were excluded from the sample. This process produced a concluding sample of one-year end-of-year information for 91 listed commercial Bankss arising from 18 European states with a entire figure of 910 firm-year observations. Table 1 presents the informations choice process and the distribution of Bankss within states. Switzerland and Italy present the bulk of observations in the sample followed by Spain, France and Greece. We did non continue in any curtailing of the informations in the upper and lower bounds of the distributions because informations are rather dispersed within states and we besides did non desire to lose any farther observations which could deteriorate the cogency of our illations.

[ Insert Table 1 about Here ]

4.2 Testing for Capital and Earnings Management

The theoretical account that we use for proving the capital and net incomes direction is a modified version of the theoretical account used by Ahmed et Al. ( 1998 ) and is presented as follows:

LLPRit = a0 + a1MCAPit + a2EBTit + a3IFRSit + a4IFRSit*MCAPit + a5IFRSit*EBTit

+ a6Dzit + a7Dzit*MCAPit + a8Dzit*EBTit + a9IFRSit*Dzit*MCAPit

+ a10IFRSit*Dzit*EBTit + a11LnTAit + a12CFEERit + a13I”GDPit

+ bCountry silent persons + cYear silent persons + eit ( 1 )


LLPR = ratio of loan loss commissariats to entire loans

MCAP = ratio of existent regulative capital ( Tier 1 capital ) before loan loss

militias to the lower limit needed regulative capital

EBT = ratio of net incomes before revenue enhancements and LLPs to entire assets

IFRS = silent person variable. ( 1 ) if Bankss report under IFRSs, ( 0 ) otherwise

IFRS*MCAP = interaction of MCAP with type of accounting government ( IFRS )

IFRS*EBT = interaction of EBT with type of accounting government ( IFRS )

Dz = silent person variable. ( 1 ) if for observations lying below the sample median of the Z-score ( developed by Boyd et. Al. 1993 ) , ( 0 ) otherwise

Dz*MCAP = interaction of Dz with MCAP

Dz*EBT = interaction of Dz with EBT

IFRS*Dz*MCAP = interaction among IFRS, the degree of hazard Dz, and MCAP

IFRS*Dz*EBT = interaction among IFRS, the degree of hazard Dz, and EBT

LnTA = natural logarithm of entire assets

CFEER = ratio of committee and fee income to entire assets

I”GDP = alteration in gross domestic merchandise

vitamin E = mistake term

The Z mark is a metric for bank insolvency hazard developed by Boyd et Al. ( 1993 ) . The Z mark is a statistic bespeaking the solvency for each bank J in every twelvemonth T and is calculated as follows:

where J is the estimated market value that can be calculated as follows:

where cj is the figure of outstanding portions adjusted for stock splits, and pj is the portion monetary value of the last concern twenty-four hours of twelvemonth j. Ej is the market value of entire equity ( e.g. portion monetary values multiplied by figure of portions outstanding ) ; Aj is the market value of entire assets:

Aj = Ej + L

L is the book value of entire debt at the terminal of each financial twelvemonth. And Sr is the estimated criterion divergence ( SD ) of Iˆj/Aj. The Z mark is negatively associated with insolvency hazard, where Z is the figure of SDs below the mean by which net incomes must fall in order to extinguish equity. Boyed et Al. ( 1993 ) defines the downside hazard as being negative values of the Z mark ( see Yasuda et al. , 2004 ) . In other words, the higher the value of the Z-score the lower the insolvency hazard.

We have besides included in the theoretical account state silent persons in order to encapsulate any unobservable state specific effects. We have besides included twelvemonth silent persons to capture clip specific effects and besides to cover with the job of heteroscedasticity in the error term. We control for the IFRS and solvency hazard impacts individually and at the same time by presenting relevant factors bit by bit in the empirical theoretical account in order to analyze the consequence of each factor on director ‘s determination to dissemble net incomes and capital via LLPs.

In theoretical account ( 1 ) we take into consideration the impact of IFRS acceptance by European states on the direction of capital and net incomes. We expect a positive coefficient between IFRS and LLP. We have introduced a 2nd dichotomous variable Dz which capture the consequence of insolvency hazard. We expect a negative association with LLPs. Similar to Anandarajan et. Al ( 2007 ) we use the ratio of net incomes before revenue enhancements and loan loss commissariats to entire assets ( EBT ) and the interaction term IFRS*EBT to prove the usage of LLPs for net incomes direction during the pre and post-IFRS periods. We expect IFRS to lend to less net incomes direction patterns by Bankss. Consequently, we expect a positive coefficient for EBT if bank directors ‘ determinations on loan loss commissariats are motivated by net incomes direction and the coefficient of the interaction term IFRS*EBT ( which captures the impact of IFRS on net incomes direction via LLPs ) is expected to be smaller in size relation to the coefficient of the pre-IFRS period.

We have besides included the interaction term Dz*EBT to analyze the net incomes direction in relation to insolvency. We expect a positive coefficient. We test the interaction between IFRS, insolvency and net incomes ( IFRS*Dz*EBT ) . If high hazard Bankss use LLPs more sharply to pull off net incomes in the post-IFRS period the coefficient will be positive and statistically important.

Similar to Anandarajan et. Al ( 2003, 2007 ) , Ahmed et. Al ( 1998 ) and Beatty et. Al ( 1995 ) we use the ratio of existent regulative capital before loan loss militias to the lower limit needed regulative capital ( MCAP ) to analyze the usage of LLPs for capital direction. We expect a negative mark on the coefficient of MCAP. The variable IFRS*MCAP measures the difference in the usage of LLPs for capital direction in the post-IFRS period. We expect the relationship between LLPs and capital direction to worsen after the issue of IFRS. This will be depicted with a positive coefficient on IFRS*MCAP variable.

Additionally, the interaction variable Dz*MCAP is included to analyze whether solvency is related to inducements for capital direction. A negative coefficient is expected. The variable IFRS*Dz*MCAP indicates the interaction of high hazard Bankss with capital adequateness ratio in the post-IFRS government. If the inducement to utilize LLPs to pull off capital is higher for high hazard Bankss we expect a negative coefficient.

Our theoretical account includes several control variables. I”GDP is the one-year growing rate of every state ‘s gross domestic merchandise. This variable captures the consequence of macroeconomic conditions ( concern rhythm ) on loan loss commissariats ( Perez et. al 2008 ) . Therefore, we control for LLP cyclical form. We expect a negative coefficient. Similar to Anandarajan et Al ( 2007 ) we include the ratio of committee and fee income to entire assets ( CFEER ) . A higher CFEER ratio indicates a bank ‘s involvement in non-depository activities. Under these fortunes Bankss may apportion extra LLPs to supply a sense of assurance and safety to the market. Therefore, we expect a positive coefficient. Finally, similar to Perez et. Al ( 2008 ) we include the natural logarithm of entire assets as a control variable for bank size. Although the relation between LLP and size is non monotonic we expect that higher recognition portfolio variegation for large Bankss would propose a negative mark.

5. Empirical Consequences

5.1 Descriptive Statistics & A ; Correlations

Descriptive statistics for the full sample ( pre-IFRS and post-IFRS ) are presented in Table 2. The mean ( average ) value of LLP in the pre-IFRS period is 0.0057 ( 0.0044 ) while the mean ( average ) value in the post-IFRS period additions to 0.0063 ( 0.0052 ) . The mean ( average ) value of Tier 1 capital over the lower limit needed capital ( MCAP ) shows a important lessening from 1.789 ( 0.706 ) in the pre-IFRS period to 1.087 ( 0.739 ) in the post-IFRS period. Our findings indicate a material addition in both commissariats and liabilities in the station IFRS epoch. The addition in LLPs nevertheless were proportionally higher.

[ Insert Table 2 about Here ]

Table 3 provides the Pearson correlativity coefficients of the sample variables. LLPs are negatively and significantly correlated to EBT ( -0.252 ) and LnTA ( -0.66 ) , but insignificantly correlated with MCAP and I”GDP. LLPs are positively and significantly correlated with CFEER ( 0.094 ) . These are consistent with anterior surveies.

[ Insert Table 3 about Here ]

5.2 Findingss on Capital Management and Earnings Management

Estimates of the four different specifications in our theoretical account are reported in Table 4. The first specification includes the interaction of the dichotomous variable IFRS with EBT and MCAP to prove hypotheses H2a and H1b. The 2nd specification includes the interaction Dz*EBT and Dz*MCAP to prove hypothesis H1c. The 3rd specification includes all interaction variables commanding for the degree of hazard and the acceptance of IFRS. The last specification includes the old interaction variables and two tripartite interaction variables IFRS*Dz*EBT and IFRS*Dz*MCAP. All theoretical account specifications have been estimated including state and twelvemonth silent persons.

The consequences for the first equation indicate a negative but non statistically important association between MCAP and LLPs. When IFRS*MCAP is included the coefficient is positive but still non important. This indicates that LLPs are non used as a tool in capital direction. The coefficient of EBT is negative and important at the one per cent which is contrary to hypothesis H1a. Our decision is that LLPs are non used for net incomes direction intents over our full period of analysis. The coefficient of the interaction IFRS*EBT is besides negative and statistically important ( -0.090 ) at the one per cent degree.

In all theoretical account specifications the silent person variable Dz is negative and statistically important bespeaking that high hazard Bankss maintain higher degrees of loan loss commissariats relative to low hazard Bankss. The interaction term Dz*MCAP is negative proposing that insolvency hazard is non important for fluctuations in capital direction ( Hypothesis 2c ) . However, the interaction term DZ*EBT is positive and statistically important ( at the one per centum degree ) suggesting that Bankss with higher chance of insolvency have greater inducements in utilizing loan loss commissariats for pull stringsing accounting income Numberss. This determination corroborates hypothesis H2c.

The coefficient of the IFRS silent person was positive and important in all theoretical account specifications proposing that the acceptance of IFRS resulted in a important addition of loan loss commissariats by EU bank directors. When the tripartite interaction variables IFRS*Dz*EBT and IFRS*Dz*MCAP are included it appears that high hazard Bankss engage in comparatively greater net incomes direction and capital direction in the post-IFRS epoch. Although the grounds for capital direction is weak, the comparative coefficient for net incomes direction ( EBT ) is positive and statistically important ( 0.092 ) proposing that riskier Bankss have greater leaning to prosecute in aggressive net incomes direction irrespective of the accounting government. With regard to the control variables, bank size and the degree of economic growing seem to negatively impact the degree of LLPs ( in all theoretical account specifications ) . Small Bankss maintain higher degrees of LLPs. This may be attributed to less efficient schemes to recognition hazard variegation. The negative coefficient of the GDP growing variable is declarative of the cyclical form of LLPs ( i.e. Bankss in periods of recession tend to keep increased commissariats for protection against unexpected losingss ) . Finally, the coefficient of CFEER has the expected positive mark bespeaking that Bankss that engage in non depositary activities tend to apportion extra loan loss commissariats to advance the image of a “ safer ” establishment.

[ Insert Table 4 about Here ]

5.3 Sensitivity Analysis

In order to verify the hardiness of our consequences we performed several sensitiveness trials with regard to the survey period and the appraisal of cardinal variables. First, we rerun all equations excepting 2008 informations because that twelvemonth was represented by broad spread fiscal crisis. Our consequences did non alteration. Hence, we conclude that our findings are robust with regard to the appraisal window. We besides winsorized one per centum of the higher and lower terminals of our observations to extenuate the effects of outliers on our illations and re-estimated our theoretical accounts. There were no important differences in our consequences.

Additionally, we tested for the association between LLPs and capital direction ( measured as Tier II capital ) . Models ( 1 ) and ( 2 ) were re-estimated by specifying MCAP as the ratio of regulative capital ( Tier II ) to the lower limit needed regulative capital. Our aim was to analyze whether keeping LLPs to a upper limit of 1.25 per cent of risk-weighted assets changes the relation between LLPs and the aforesaid variables. Untabulated consequences show no grounds to bespeak that net incomes and capital direction behaviour alteration significantly in the presence of Tier II capital.

To prove for Basel II Accord effects on our consequences we split our sample into two sub-periods i.e. pre-Basel II ( 1999-2005 ) and post-Basel II ( 2006-2008 ) and re-estimated all theoretical account specifications. Statistically important consequences suggested that Bankss perform less capital direction in the post-Basel II period and high hazard Bankss tend to prosecute in more aggressive net incomes direction and signaling via LLPs relative to their less hazardous opposite numbers. However, no grounds was found for net incomes direction between the two sub-periods. Finally, Spain is the lone state in Europe using a “ statistical proviso ” for calculating LLPs get downing June 2000. We ran the consequences dropping Spanish Bankss from the sample. The consequences remained qualitatively unchanged.

Some research workers have suggested that LLPs be dichotomized into its “ discretional ” and non-discretionary ” constituents ( see Hasan and Wall, 2004 ; Lobo and Yang, 2001 ) . To command for the non-discretionary constituent of LLPs we introduced the variable I”LOAN in the theoretical accounts ( estimated as the one-year alteration of the ratio of entire loans to entire assets of bank I at clip T ) . The influence of this variable on loan loss commissariats depends on the quality of incremental loans ( Lobo and Yang, 2001 ) . Our empirical findings remain unchanged.

Since our research sample comprises pooled cross-sectional and clip series informations the t-statistics could be overstated. In order to command for this beginning of prejudice we conducted a panel information analysis and re-estimated all theoretical accounts utilizing the fixed consequence method. The consequences ( untabulated ) are consistent with the consequences reported earlier on tabular arraies 4 and 5. Finally, we besides tested for compulsory IFRS acceptance prejudices ( including a silent person to the station 2005 epoch ) . Cairns ( 1999 ) and Street and Gray ( 2002 ) suggest that early adoptive parents might follow a differential attack to accounting quality when compared to compulsory adoptive parents. Consequences nevertheless are qualitatively similar. Finally, we note that there are no important survivorship prejudices in our sample since none of our sample Bankss engaged in amalgamations or acquisitions or filed for bankruptcy during the period of our analysis.

6. Decisions

The needed acceptance of IFRS in Europe get downing 2005 spawned research on the deductions and effects of IFRS on a figure of of import issues, including, but non limited to, cost of capital, information dissymmetry, truth of analysts prognosiss and quality of reported net incomes. In this paper we focus on that facet of this research niche analyzing the influence of IFRS on net incomes direction. In general, the greater the net incomes direction, the lower the reported net incomes quality. There are two opposing positions: one position proposing that IFRS should better net incomes quality and the other that it could cut down quality of reported net incomes. The consequences on whether IFRS does in fact addition reported quality of net incomes are assorted. Van Tendeloo and Vanstraelen ( 2005 ) for illustration, find no difference in net incomes direction behavior between the pre and station IFRS regimes. Barth et Al ( 2008 ) , nevertheless, conclude that IFRS does cut down net incomes direction and better net incomes quality. We contribute to the extant literature by concentrating on whether IFRS alterations net incomes direction behavior for fiscal establishments. The other surveies used a assortment of non-financial industries in their sample. Our sample consisting fiscal establishments are homogeneous. We use extended informations consisting EU Bankss stand foring 18 states covering a 10 twelvemonth period straddling pre and station IFRS regimes. Overall, our findings show that the execution of IFRS has non significantly mitigated net incomes direction behavior. However, we besides find that more hazardous Bankss tend to prosecute in greater net incomes direction after the IFRS was implemented. As a subordinate issue we besides examined if capital direction behavior had changed after execution of IFRS and happen no important alteration.

We make two parts to the literature. First, we contribute to the literature on the deductions of IFRS on net incomes direction and reported net incomes quality. Second, there is a watercourse of literature analyzing the usage of LLPs for net incomes and capital direction. We find that hazardous Bankss use LLPs for net incomes direction intents peculiarly in the post-IFRS epoch. The findings on net incomes direction suggest that the regulative government might under IFRS might be lax. Probably, the recreation from specific national regulations to fair presentation of LLPs under IFRS may hold supply greater latitude to directors. Based on our dataset we note that this might be peculiarly true in European states with slack enforcement regulations ( e.g. Greece ; Portugal ) . Our consequences are robust to several sensitiveness trials including alternate definitions of bank capital, state specific effects, ordinance on bank capital demands, and discretional constituent of LLPs.

We end by supplying suggestions for future research. A farther extension of this survey is to analyze the market effects of IFRS. We besides note that the explanatory power of the theoretical accounts could be enhanced by integrating corporate administration variables in the analysis ( e.g. , board construction and independency, foreign directorship, CEO term of office and dichotomy ) and ownership construction variables. Integrating these variables and widening this survey would be another avenue for future research.