Earnings Management by Credit Unions: In Managers’ or Members’ Interest?

Abstract

Relying on an agency theory perspective, this study examines the extent of earnings management in US credit unions through loan loss provisions (LLP). The context of member-owned credit unions provides a different set of financial reporting incentives than the one typically found in shareholder-owned banks, thus providing an opportunity to extend earnings management research. Using 83,634 quarterly observations from 2003 to 2017, we examine the use of discretionary loan loss provisions (DLLPs) to smooth earnings and avoid earnings declines. We also assess whether earnings management is associated with merger intentions. Results reveal that US credit union managers do engage in income smoothing through DLLPs, especially in larger, better-capitalized, federally chartered, and less profitable institutions. Moreover, earnings management is more pronounced among credit unions pursuing mergers, particularly in the post-2009 period, and credit unions whose managers want to increase their compensation. This study contributes to the earnings management literature by focusing on credit unions, a distinct and underexplored organizational form. Our findings highlight how governance structures—characterized by weak member oversight and limited board expertise—may facilitate managerial discretion in financial reporting. The study offers important implications for regulators and stakeholders regarding financial transparency and governance in not-for-profit financial institutions.