Regulatory Capital, Tax, and Earnings Management Effects on Loan Loss Accruals in the Canadian Banking Industry

Posted: 3 Jul 1998

See all articles by Peter F. Chen

Peter F. Chen

Hong Kong University of Science & Technology (HKUST) - Department of Accounting

Lane Daley

Independent

Abstract

This paper examines the degree to which managerial discretion over accruals relating to loan losses in the Canadian banking industry during 1977-87 may have been utilized to manage regulatory capital, taxable income, and reported earnings. These years reflect a unique period in which accounting and regulatory practices differed significantly from the post-1987 period. These prior practices created different types of incentives and highlighted different policy issues, such as the role of tax benefits in loan loss accrual decisions. We model a three-equation simultaneous system around three annual discretionary choices: the amount of loan loss experience accrued (based on specific provision), the size of reserve transfer to the Appropriation for Contingencies (based on general provision), and the extent of external regulatory capital raised. Results indicate strong support for the capital maintenance predictions and weaker, but significant support for the tax management predictions. Results do not support the predictions of the earnings management hypothesis.

Note: Sadly, Dr. Daley died in August 1998.

JEL Classification: G21, G28, M41

Suggested Citation

Chen, Peter Fusheng and Daley, Lane, Regulatory Capital, Tax, and Earnings Management Effects on Loan Loss Accruals in the Canadian Banking Industry. Available at SSRN: https://ssrn.com/abstract=2591

Peter Fusheng Chen (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Accounting ( email )

Clear Water Bay
School of Business & Management
Kowloon
Hong Kong PRC
852-2358-7572 (Phone)

Lane Daley

Independent

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