Earnings Management and Banks Performance: Evidence from Europe

The primary purpose of this study is to examine whether earnings management affects banks’ current and future performance. It analyses the relationship between discretionary loan loss provision and both return on assets (ROA) and return on equity (ROE). Using a sample consists of 477 bank-year observations that representing 55 European banks over the period from 2001 to 2015, we provide new evidence that European banks with high levels of earnings management that occurs via discretionary loan loss provision experience inferior performance (measured via ROA and ROE) in the current and subsequent years. Our results show that the negative impact of earnings management (which takes place in a specific year) feeds through into the following years. The results of the analysis emphasis the important implication to many interested parties across the European Union such as regulators, investors, audit firms, and standards setters who aim to improve the financial reporting quality in the banking industry.