EU Banks’ Accounting Policy Decisions and Market Influence

Abstract

This study investigates the impact that market discipline mechanisms have on European Union (EU) banks’ accounting policy decisions. We investigate the association between the level of loan loss provisions (LLPs) with earnings before provisions and taxes when depositors appear to withdraw their funds and demand higher deposit rates. We examine whether market discipline motivates banks to adjust earnings through accounting accruals. Empirical findings suggest that the demand for higher deposit rates limits management’s accounting discretion. By contrast, withdrawals appear to encourage managers to use income smoothing via LLPs. The observed associations appear to be conditioned by banks’ systemic importance and capital adequacy levels.