Competition and the Use of Discretion in Financial Reporting: Evidence from Community Banks

57 Pages Posted: 25 Jan 2017  

Rimmy E. Tomy

University of Chicago

Date Written: January 11, 2017

Abstract

This paper examines how an increase in the threat of competition distorts firms' financial reporting. I consider two channels: actions taken by managers as well as by regulators.

Using state-level changes in branching regulation, I find that geographically-constrained community banks increased their loss provisions and appeared less profitable when faced with the threat of entry by competitors. Future losses do not justify the increase in provisions. The effect is consistent with both managers' and regulators' use of discretion in financial reporting, driven by managers' entry-deterrence objective and regulators' mandate to ensure safety and soundness of the financial system.

Survey-based evidence collected as part of this study supports the premise that banks prefer to locate in markets where incumbents have high profitability and low credit losses, and that banks use competitors' financial statements in analyzing their competition. Survey evidence also suggests that regulators' expectations are a leading factor in banks' over-provisioning for loan losses.

Keywords: Financial Reporting, Product Market Competition, Entry Deterrence, Community Banking, Regulator Incentives, Loss Provisioning

Suggested Citation

Tomy, Rimmy E., Competition and the Use of Discretion in Financial Reporting: Evidence from Community Banks (January 11, 2017). Available at SSRN: https://ssrn.com/abstract=2903918 or http://dx.doi.org/10.2139/ssrn.2903918

Rimmy Elizabeth Tomy (Contact Author)

University of Chicago ( email )

Booth School of Business
5807 S Woodlawn Ave
Chicago, IL 60637
United States

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