Managing Financial Reports of Commercial Banks: The Influence of Taxes, Regulatory Capital and Earnings

Abstract

This paper examines whether managerial discretion over loan loss accruals, accounting related transactions such as sales of investment securities, and financing transactions are used to manage capital, earnings or taxes. We model discretion over these decisions using a system of five equations generating from an underlying cost minimization problem. The estimated parameters of the system suggest that banks manage both capital and earnings using accounting, investment and financing discretion exercised over these transactions. The framework we use highlights trade-offs among accounting and financing transactions. We find that accounting sources of capital in part determine banks' propensity to issue new securities and that the positive reported capital effects of gains from transactions such as asset sales in part determine managers' willingness to charge-off loans.

JEL Classification: M41, G21