Earnings Management and Corporate Governance: An Empirical Study of the Listed Commercial Banks in Cyprus
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Abstract
This dissertation is an examination of the incentives, opportunities and disincentives for earnings management. The research was conducted for the listed, commercial banks in Cyprus. The period examined includes the years 2002-2011, for which the required information was available. After having considered the literature review, the regulations that affect banks’ financial reporting and the results from interviews conducted the research hypotheses were formulated and tested with regressions.
The conclusions drawn from this empirical analysis are as follows. The existence of a cash bonus and leverage did not create incentives for earnings management through the use of discretionary accruals. This finding was observed because the bottom line profit was not considered in cash bonus decisions. In addition, most of the banks’ debt was in the form of deposits; deposit schemes do not include covenants that have to be met like other debt contracts. Discretionary accruals were therefore saved so that they could be used to manage earnings and increase regulatory capital. The evidence suggests that when the capital adequacy ratio was low, earnings were managed in order to artificially boost the capital base. The empirical results confirm that regulators perceived banks as being adequately capitalized and hence did not scrutinize bank practices. Banks were then able to grow and to grant loans very generously. Recognition of more interest revenue helped to cover higher interest paid to depositors and also helped executives to earn their bonus. The evidence also suggests that when the CEO was also the chairman of the board, the quality of earnings deteriorated. However, when directors owned shares and as board independence increased, the quality of earnings was improved.
Considering the recent financial crisis and that one of the largest banks has collapsed, the results of this thesis should be of great importance to boards and their audit and remuneration committees, shareholders, depositors, auditors and the supervisory authorities.