The purpose of this paper is to study the influence of managerial ability on the quality of their financial reporting. Using a large bank sample from nine different countries and for the time period 2004–2010, we expect that bank earnings quality and accounting conservatism increase with more able managers that disclose more accurate earnings and who report higher information about banks’ future earnings and cash flows. The results confirm that managerial abilities play a significant role in the quality of financial reporting in banks, and that capable bank managers are less likely to manage earnings opportunistically. This study is timely and relevant given the recent emphasis on earnings quality of banks over the last few years, and the criticisms of managerial abilities after the financial crisis. The evidence from this study can help standard-setters and regulators to better understand the business practices and accounting behavior of banks in the light of managerial abilities.
Do we know the factors that affect quality reporting in banks? Previous literature on financial reporting quality has mainly focused on the influence of governance characteristics of nonfinancial firms (Beekes, Pope, & Young, 2004; García Lara, García Osma, & Penalva, 2009). Several other studies have shown the association between financial reporting quality of non-financial firms and several management variables, such as CEO attributes (Francis, Huang, Rajgopal, & Zang, 2008; Koh, 2011), executive overconfidence (Schrand and Zechman 2009), and financial expertise (Matsunaga & Yeung, 2008). According to these studies, managers play a key role in the financial reporting process and exert a major influence on earnings through their operating decisions (Choi, Han, Jung, & Kang, 2015). These results are supported by the upper echelons theory, where managers are not effectively interchangeable, and idiosyncratic differences in personal values and cognitive styles can lead them to make different choices, particularly in complex situations (Bamber, Jiang, & Wang, 2010). These managerial abilities (MAs) are even more relevant in the bank industry due to the large informational asymmetries, opaqueness, and complexities of this sector (Levine, 2004). Despite the relevance of managerial ability, most of the previous literature has largely ignored the consequences of managerial skills on financial firms. However, banks have larger informational asymmetries and a different capital structure than non-financial firms. Managers in banks face superior complexity arising from many types of risks e credit risk, interest rate risk, prepayment risk, exchange rate risk, liquidity risk, among others (Craig Nichols, Wahlen, & Wieland, 2009). According to Bamber et al. (2010), in complex and ambiguous situations managers operate within the bounds of rationality, and within these bounds their choices can be influenced by their idiosyncratic experiences and values. Therefore, in order to prevent depositors losing confidence in banks and to avoid reputational losses, able managers may have a strong incentive to avoid their earnings becoming negative, which affects their accounting choices. In this regard, and according to Shen and Chih (2005), bank insiders have a high incentive to hide asset substitution behavior through earnings management, because bank assets present bankers with ample opportunities for risk or asset substitution, and their high leverage inclines them to do so.