Bank earnings management using commission and fee income: The role of investor protection and economic fluctuation

Abstract

Purpose

The purpose of this paper is to investigate whether banks use commission and fee (CF) income to manage reported earnings as an income-increasing or income smoothing strategy.

Design/methodology/approach

The authors employ the regression methodology to detect real earnings management.

Findings

The authors find that banks use CF income for income smoothing purposes and this behaviour persists during recessionary periods and in environments with stronger investor protection. The implication of the findings is that bank non-interest income which achieves diversification gains to banks is also used to manipulate reported earnings.

Research limitations/implications

The findings show that real earnings management is prevalent among banks in Africa. Further research into earnings management should examine real earnings management among non-financial firms in developing regions.

Practical implications

From an accounting standard setting perspective, the evidence suggests the need for national/international standard setters to adopt strict revenue recognition rules that ensure that banks or firms report the actual fees they make, and to discourage banks from delaying (or deferring) the collection of fee income to manage or smooth reported earnings opportunistically.

Originality/value

This study contributes to the positive accounting theory (PAT) literature which examines the accounting and non-accounting decisions that influence managers’ choice of accounting methods in financial reporting. Extending the PAT, the authors show that certain conditions can incentivize managers to engage in earning management such as during recessions and weak institutional quality or weak investor protection.

Citation

Ozili, P.K. and Outa, E. (2019), "Bank earnings management using commission and fee income: The role of investor protection and economic fluctuation", Journal of Applied Accounting Research, Vol. 20 No. 2, pp. 172-189. https://doi.org/10.1108/JAAR-02-2018-0030