Determinants of Signaling by Banks through Loan Loss Provisions

Abstract

This study investigates whether bank managers use their discretion in estimating loan loss provisions to convey information about their banks' future prospects. Bank managers' propensities to signal their private information vary cross-sectionally because they face different conditions and have different incentives. This study hypothesizes that the propensity to signal varies negatively with bank size and positively with earnings variability, future investment opportunities, and degree of income smoothing. The empirical evidence supports these predictions. It suggests that the propensity to signal is positively related to the degree of information asymmetry and that bank managers attenuate perceived undervaluation of their banks by communicating their private information about their banks favorable future prospects.

Keywords: Signaling, Loan Loss Provision, Earnings Variability, Investment Opportunity Set, Income Smoothing

JEL Classification: C23, G14, G34, J41, M41, M43