The impact of corporate governance mechanisms on EU banks’ income smoothing behavior

Pages931-953
DOIhttps://doi.org/10.1108/CG-09-2017-0234
Published date10 July 2018
Date10 July 2018
AuthorKonstantinos Vasilakopoulos,Christos Tzovas,Apostolos Ballas
Subject MatterCorporate governance,Strategy
The impact of corporate governance
mechanisms on EU banksincome
smoothing behavior
Konstantinos Vasilakopoulos, Christos Tzovas and Apostolos Ballas
Abstract
Purpose This paper aims to investigate the impact that governance mechanisms have on European
Union ‘banksincome smoothing behavior.
Design methodology/approach The authors examine the impact that corporate governance
mechanisms included in European Commissions’ proposals regarding the improvement of corporate
governance mechanisms(Green Paper) have upon European Union banks’ accountingpolicy decisions
regardingthe level of loan loss provisions (LLPs). In addition,the authors examine whether banks’ capital
structure operates as an effective internal corporate governance practice. The authors investigate the
association between certaincorporate governance characteristics and the level of LLPs for a sampleof
98 banks from 23 European Union countries for the period of 2010-2013, in the aftermath of the 2008
financial crisis. To test the hypotheses, a multivariate regression model is run. Similar to previous
research,the authors use ordinary least squares analysisto test the results.
Findings Empirical findings provideevidence that there is a positive association between LLPs and
accountingincome, implying the existence of an income-smoothingpattern of provisions. In addition,the
results suggest that banks managers’ decision to smooth income may differ with regard to the board
structure,the level of leverage and the provision of disclosurefor remuneration for chief executive officer.
Originality/value The findings of this study contribute to the existing literature concerning banks’
income smoothing behavior. These findings can be useful to regulators, as the authors provide some
evidenceregarding the effectiveness of theEuropean Union corporate governanceframework.
Keywords Board of directors, Banks, Remuneration, Provisions, Corporate governance
Paper type Research paper
1. Introduction
Corporate governance mechanisms contribute in the improvement of quality of the
accounting information provided by corporations. Previous research has found that
managers are more likely to use accounting accruals to smooth and/or manipulate income
when corporate governance mechanisms are ineffective (Brown et al., 2011). This study
investigates the impact that corporate governance mechanisms have uponEuropean Union
(EU hereinafter) banks’ income smoothing behavior. We focus on the initiativestaken by EU
regulatory authorities, in the aftermath of 2008 financial crisis, for the improvement of
corporate governance framework of EU banks. In particular, we examine whether the
limitations in the existing corporate governance framework that were identified in the
European Commission’s Green Papers of 2010 and 2011 affect the accounting policy
decisions of EU banks. These guidelinesrefer to the structure, the duties and the operations
of the board of directors; the rights of shareholders; the disclosure of directors and chief
executive officers’ (CEOs’ hereinafter) remuneration; the responsibilities and duties of the
external auditors; and the roleof supervisory authorities.
Konstantinos
Vasilakopoulos is a PhD
candidate at the
Department of Accounting
and Finance, Athens
University of Business and
Economics, Athens,
Greece.
Christos Tzovas and
Apostolos Ballas are Dr at
the Department of
Accounting and Finance,
Athens University of
Business and Economics,
Athens, Greece.
JEL classif‌ication G21, G28,
G30, G34, M41, M48
Received 29 September 2017
Revised 30 September 2017
27 February 2018
12 May 2018
Accepted 16 May 2018
This research is financed by the
Research Centre of Athens
University of Economics and
Business, in the framework of
the project entitled Original
Scientific Publications. This
paper is a revised and
expanded version of a paper
entitled “Corporate governance
mechanisms and income
smoothing: the case of
European Union Banks”
presented at 2018 Clute
International Conferences in
Washington DC.
DOI 10.1108/CG-09-2017-0234 VOL. 18 NO. 5 2018, pp. 931-953, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 931
We study whether EU banks’ accounting policy decisions are associated with the
characteristics of the banks’ board of directors. In addition to the issues raised in European
Commission’s Green Papers regarding the duties and the operations of the board of
directors, we explore theimplications that boards’ structure (one-tier vs two-tiersystem) can
have on banks’ corporate governance environment. Furthermore, we investigate the impact
that the disclosure of CEOs’ remuneration can have upon banks’ accounting policychoices.
Moreover, we examine whether banks’ capital structure operates as an internal corporate
governance practice by affectingbanks’ target regulatory capital ratios.
We use a sample of sample 98 banks from23 European Union countries (392 observations)
for the period of 2010-2013. In line with previous research, we examine loan loss provisions
(hereinafter, LLPs) as a smoothing accounting tool. To test our hypotheses, we conduct a
univariate analysis and we runa multivariate regression model. Similar to previous research,
we use an ordinary least squares (OLS) analysis to test our results.
Our results suggest that LLPs remain a significant income-smoothing tool for EU banks. In
addition, the empirical findings of this study indicate that board of directors’ characteristics
are associated with the level of banks’ LLPs. Furthermore, the structure of the board of
directors along with the disclosure of the CEO’s remuneration are associated with banks’
accounting discretion. In particular,our findings imply that income smoothing through LLPs
is higher for banks with dual system boards and banks that do not provide information
about CEO remuneration. In addition, it appears that banks with higher target capital ratios
are more likely to use LLPs to smooth their income.
The findings of this study contribute to the existing literature concerning firms’ income
smoothing behavior by providing insights concerning banks’ corporate governance
mechanisms. We investigate whether the corporate governance characteristics of banks
have an impact upon their accounting policy decisions. Banks face corporate governance
issues similar to those of other firms and have similar corporate governance mechanisms.
Yet, their institutional and regulated operational environment has certain attributes that
require special examination. Furthermore, these findings can be useful to regulators, as we
provide some evidence regarding the impact of banks’ governance mechanisms on
managerial discretion, focusing on the period after the issuance of the Green Papers by the
European Commission. In addition, we provide evidence that the structure of the board of
directors (one-tier vs two-tier system) is a corporate governance characteristic that may
have influenced the quality of banks’ reports. Furthermore, our results indicate that bank’s
LLPs’ accounting policies are affected by the banks’ disclosure policy regarding CEO
remuneration and the level of each bank’sleverage.
The remainder of this paper is organized as follows. Section 2 presents the regulatory and
accounting background of this study. In Section 3, we review the literature and outline the
hypotheses being tested. Subsequently, we present the sample and the research methods
used (Section 4). Section 5 reports the empirical results of univariate and multivariate
analyses. The final section (Section 6) concludes the paper and discusses the practical
implications of our results.
2. Background
To place this study in its context, we outline some aspects of the corporate governance
framework within which EU banks operated during 2010-2013. In addition, we present the
accounting background regardingthe treatment of LLPs.
2.1 Regulatory authorities’ response to 2008 financial crisis
The financial crisis of 2008 raised concerns among investors, policymakers and regulators
regarding the financial soundness of EU banks and the effectiveness of EU banks’
PAGE 932 jCORPORATE GOVERNANCE jVOL. 18 NO. 5 2018

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