Does Managerial Sentiment Affect Accrual Estimates? Evidence from the Banking Industry

Abstract

Defining managerial sentiment as managers’ beliefs about future firm outcomes that are unjustified by the information available to them, we hypothesize and find that managerial sentiment is associated with unintentional errors in accrual estimates. Using a sample of public banks, we find that: (1) managerial sentiment is negatively associated with loan loss provision estimates; (2) loan loss provision estimates made in periods of higher (lower) sentiment are associated with more (less) future charge-offs; and (3) the effects of sentiment are greater for firms with more “uncertain” or more “difficult-to-predict” charge-offs. We find the same results using a sample of private banks, suggesting that the bias in the provision estimates is unintentional, as opposed to strategic. These results are robust to firm-level determinants of loan loss provisions, macroeconomic variables found to affect either loan loss provisions or measures of sentiment, and multiple proxies for managerial sentiment. We contribute to the literature by documenting evidence on how unintentional biases linked with managerial sentiment influence financial reporting decisions.

Keywords: Sentiment, earnings quality, accruals, loan loss provisions, banking industry

JEL Classification: G21, G28, M41