Peer Pressure in Reporting Discretion: Evidence From Bank Holding Company Subsidiaries

Abstract

Subsidiaries of a firm can use their reporting discretion for several goals, such as reporting earnings comparable to other subsidiaries or reporting earnings that are smooth over time. Prior theoretical work on reporting discretion recognizes the tension among these goals (Holmstrom, 1982; Demski and Sappington, 1974), but empirical work has not sufficiently examined it. This study exploits the bank holding company setting to investigate how subsidiaries use reporting discretion to navigate these competing objectives. I find that while subsidiaries use reporting discretion to smooth their own earnings, they also use reporting discretion to herd around the earnings of internal peers. Through a number of cross-sectional analyses, I find that this herding behavior appears consistent with relative performance evaluation motivations. These results provide new insight into prior mixed findings on the reporting choices of bank holding companies.

Keywords: bank, relative performance evaluation, loan loss provision, subsidiary

JEL Classification: G21, M41