Regulatory Capital, Tax, and Earnings Management Effects on Loan Loss Accruals in the Canadian Banking Industry
Posted: 3 Jul 1998
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: Suggested Citation