Examining Managerial Misbehavior in Asian Banks through Loan Loss Provisions*☆

• DOI: http://doi.org/10.1111/ajfs.12307
• Published date: 01 August 2020
• Author: Md. Abul Kalam Azad,Paolo Saona
• Date: 01 August 2020

Examining Managerial Misbehavior in Asian

Banks through Loan Loss Provisions*

Paolo Saona**

Richard A. Chaifetz School of Business, Saint Louis University, Spain

Department of Business and Economics, Universidad Cat

olica de la Sant



ısima Concepci

on, Chile

Md. Abul Kalam Azad

Department of Business and Technology Management, Islamic University of Technology, Bangladesh

Received 26 January 2019; Received in current form (2

nd

revision) March23, 2020; Accepted 31 March 2020

Abstract

This paper reviews the impact of corporate ownership concentration, insider ownership, and

the development of regulatory and financial systems on the opportunistic behavior of man-

agers to alter financial reporting. By using the panel data technique with a sample of banks

from 25 Asian countries, the major findings indicate that ownership concentration as well as

insider ownership positively impact the banks’ accrual-based earnings management. Results

also reveal that an improvement in regulatory and financial systems restricts executives’

capacity to manage earnings. Islamic banking and IFRS adoption reduce the manipulation of

earnings. Policy implications from the results are also discussed.

Keywords Asia; Bank; Corporate governance; Earnings management; Loan loss provision;

Ownership structure

JEL Classification: C23, G21, L2

1. Introduction

While beneficial corporate governance reforms have been implemented throughout

the world (McGee, 2009), corporate scandals continue to damage businesses (Aguil-

era and Crespi-Cladera, 2016). Many of these corporate scandals had their origin in

the opportunistic manipulation of financial reporting. In the banking industry,

accrual-based earnings management is usually performed through discretionary loan

loss provisions (Kanagaretnam et al., 2004; Yang, 2009; Ozili, 2015), which

*The authors thank the valuable comments of Donghyun Park, Kazi Sohag, Md. Yousuf,

Bidisha Chakrabarti, Roberto Pascual, Pau Balart, two anonymous referees, and the seminal

participants at the Asia Economic Community Forum 2018, Incheon, South Korea. We also

thank Allison Kittleson and Ryan McWay for their capable research assistance.

**Corresponding author: Richard A. Chaifetz School of Business, Saint Louis University, Avda.

del Valle, 34 28003 Madrid, Spain. Tel: +34-9155-4858 (ext. 251), email: paolo.saona@slu.edu.

Asia-Pacific Journal of Financial Studies (2020) 49, 581–624 doi:10.1111/ajfs.12307

©2020 Korean Securities Association 581

corresponds to opportunistic earnings management. Accrual-based earnings man-

agement is linked to the use of managers’ judgment in financial reporting, which

aims to mislead shareholders from true firm performance (Healy and Wahlen,

1999).

Banks in the Asian region have experienced several financial crises in last few

decades. Prior studies reveal that in the event of financial instability, banks are lib-

eral in earnings manipulation (Giroux, 2008; Manzaneque et al., 2016). But when

the market becomes aware of such exploitation (i.e., Punjab National Bank in India,

Higashi-Nippon Bank in Tokyo, Sonali Bank in Bangladesh, Asia Wealth Bank in

Myanmar, etc.), financial institutions experience a substantial value loss (Man-

zaneque et al., 2016), which suggests that the market does not tolerate such

accounting practices. In a study of accounting manipulation, Karpoff et al. (2008 )

reveal that this can significantly hurt firms’ value. Examining the Tyco, Adelphia,

Global Crossings, HealthSouth, Freddie Mac, and Fannie Mae cases, Giroux (2008)

reports that earnings management had a direct association with these scandals. Sim-

ilarly, Suffian et al. (2015) conclude that there is a high correlation between oppor-

tunistic managerial behavior and earnings manipulation and that both factors

cannot be dissociated.

McGee (2009) summarizes 10 corporate governance studies conducted by the

World Bank, revealing that the indicators of corporate governance practices among

Asian countries are less than those of other regions. Like big financial scandals in

the United States or Europe, active earnings management is also found to be asso-

ciated with banking scandals in Asian countries. Asian banks that obscured their

financial information include: Oriental Bank in Bangladesh in 2006; Hallmark-Son-

ali Bank, also in Bangladesh, in 2012; BCCI in Pakistan in 2004; Olympus in

Japan in 2011; Asia Wealth Bank in Myanmar in 2008; the so-called 1MDB scan-

dal in 2009 that has been named by the BBC as a case that is still affecting Malay-

sia; Asia Pacific Breweries in Singapore in 2009; and Long-Term Credit and Bank

of Japan in 1998, among many others. Such managerial behavior in the banking

industry may cause great economic damage because of confidence lost with subse -

quent credit rationing to firms and the public in general, and capital outflows

(Hung et al., 2012). Therefore, the analysis and dynamics of such opportunistic

behavior through accrual-based earnings management—and specifically through

discretionary loan loss provisions—in the Asian banking industry is an interesting

and underexplored research field with a significant social and economic impact.

We are interested in assessing the impact of both bank-level ownership concentra-

tion features and country-level governance dynamics, such as regulatory and finan-

cial systems, on the capacity of executives to discretionarily manage earnings in

Asian banks.

This study contributes to the existing earnings management literature in several

ways. First, to the best of our knowledge, discretionary managerial behavior in the

Asian banking sector has not yet been widely studied (Sarkar et al., 2008). Only a

few studies have focused on single-country samples (Barth et al., 1999; Healy and

P. Saona and A. K. Azad

582 ©2020 Korean Securities Association

Wahlen, 1999; Park and Shin, 2004; Sarkar et al., 2008), but most of these studies

are centered on developed markets (Cornett et al., 2009; Leventis and Dim-

itropoulos, 2012; Tran et al., 2020), and only a few deal with the Asian region

(Aguilera and Crespi-Cladera, 2016; Andres and Vallelado, 2008; Claessens and Yur-

toglu, 2013; Tan, 2014), with the subsequent downside of weak extrapolation to a

wider institutional context. Consequently, we intend to close this gap in the empiri-

cal literature by considering a comprehensive multi-country sample from the unex-

plored Asian banking industry. Second, studying earnings management through the

discretionary loan loss provision is significantly associated with better decision mak-

ing. If earnings management dynamics are transparent, policy makers may take

actions to reduce their negative impact on banks and, ultimately, on the economy

as a whole. Third, from the scarce studies conducted for Asian countries—and a lso

for developed economies such as the United States and Europe—most of the empir-

ical literature has examined one or only a few of the determinants associated with

the managerial altering of financial reporting. Thus, this paper fills the literature

gap by not only examining earnings management materialized in the discretionary

loan loss provisions in the Asian banking sector, but also by determining the factors

behind these actions, which are generated at bank level as well as country level.

Hence, this study provides a more comprehensive set of determinants of managerial

misbehavior. Additionally, unlike much of the previous literature, the scope of anal-

ysis followed in this work is from a governance perspective, which allows us to

examine some determinants of opportunistic managerial behavior not widely stud-

ied in the banking literature (e.g., ownership structure features, and legal and regu-

latory institutional variables). In this respect, this study goes one step further than

the existing literature (e.g., Lassoued et al., 2017; Sullivan and Spong, 2007) by ana-

lyzing how ownership structures balanced between insiders and external sharehold-

ers provide additional insights into the transparency of financial reporting in the

Asian banking sector. Fourth, in addition to these contributions, the findings of this

paper provide policymakers and regulators with an understanding of precautions

for avoiding potential financial complexities such as earnings management. Finally,

with particular relevance for Asian banking, this study also examines major relation-

ships for the specific case of Islamic banking. In doing so, we provide further infor-

mation about the asymmetric impact of governance systems between conventional

banking and Islamic banking.

By using a model that allows us to better separate loan loss provisions in its

normal component, from the non-normal component the major findings indicate

that both ownership concentration and insider ownership exhibit a direct relation-

ship with discretionary accrual-based earnings management in the Asian banking

industry. The results also reveal that improvements in regulatory and financial sys-

tems substantially restrict earnings management. Moreover, adoption of Interna-

tional Financial Reporting Standards (IFRS) in place of local reporting systems

constrains discretionary loan loss provisions. Most notably, our results reveal that

as part of institutional variables, Islamic banks engage less actively in earnings

Earnings management in Asian Banks

©2020 Korean Securities Association 583