Government Guarantees and Banks' Earnings Management

58 Pages Posted: 21 Jun 2016 Last revised: 8 May 2019

See all articles by Manuela Dantas

Manuela Dantas

Cornell University

Kenneth J. Merkley

Indiana University - Kelley School of Business - Department of Accounting

Felipe Bastos G. Silva

University of Missouri, Columbia

Date Written: May 2, 2019

Abstract

This paper examines the effect of government guarantees on banks’ earnings management. In our first setting we examine the direct reduction of government guarantees previously granted to a specific class of German banks known as the Landesbanken. Using a difference-in-differences design, we find evidence of an increase in earnings management following the removal of explicit government guarantees. In our second setting we consider the creation of the Eurozone in 1999 as a positive shock to the relative importance of member countries’ banking system, suggesting an increase to banks’ implicit government guarantees. Similar to our first analysis, our results suggest that increasing government guarantees is associated with a statistically and economically significant reduction in banks’ earnings management. These results also persist using a difference- in-differences framework considering banks from countries not affected by the monetary union as controls and after controlling for macro and bank specific variables that were contemporaneously affected by the Euro adoption. Overall, our findings highlight the role of government guarantees as a significant and economically important determinant of banks’ financial reporting behavior.

Keywords: government guarantees; earnings management, financial reporting; loan loss provisioning

JEL Classification: M41; G21

Suggested Citation

Dantas, Manuela and Merkley, Kenneth J. and Silva, Felipe Bastos G., Government Guarantees and Banks' Earnings Management (May 2, 2019). Available at SSRN: https://ssrn.com/abstract=2797697 or http://dx.doi.org/10.2139/ssrn.2797697

Manuela Dantas

Cornell University ( email )

Ithaca, NY 14853-4201
United States

Kenneth J. Merkley

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Felipe Bastos G. Silva (Contact Author)

University of Missouri, Columbia ( email )

331 Cornell Hall
Columbia, MO 65211
United States
5738829905 (Phone)

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