Strategic use of provisions: Evidence from European multinationals

Abstract

Provisions involve a high degree of judgment by corporate managers and substantially affect companies’ reported performance, arguably making them prone to earnings management. To analyze the strategic use of provisions under International Accounting Standard (IAS) 37, we examine the notes disclosures of large European companies that provide detailed information about yearly additions and utilized and unutilized reversals of prior provisions. First, our analysis reveals that firms suspected of earnings management tend to withhold disaggregated information on their provisions. Second, by focusing on firms that disclose detailed information, our study suggests that they strategically adjust provision expenses based on their earnings management incentives. Third, considering the use of provisions over time, we find that firms exhibit increased discretionary additions and decreased unused reversals during exceptionally profitable years, suggesting corporate managers engage in “cookie jar” accounting. In contrast, firms show lower discretionary additions and higher unused reversals in periods when they risk missing earnings benchmarks. Our findings suggest the strategic use of provisions and indicate that disaggregated notes disclosures on provisions can provide relevant insights into corporate earnings management strategies.