The effect of political connections on earnings management: Evidence from ECB-supervised banks

Abstract

This study examines the effect of political connections on earnings management in banks supervised by the European Central Bank (ECB). The study analyses panel data on 58 banks supervised by the European Central Bank (ECB) from 2012 to 2019, using generalized method moment (GMM). Our results suggest a non-linear U-inverted relationship between political connections and earnings management practices. When political connections are low or moderate, they tend to favor earnings management, evidencing the opportunism of politically connected directors, with reflections on discretionary earnings management. However, in boards whose members have strong political connections, this effect is negative, suggesting that directors in this situation will not resort to discretionary practices, as they consider that they will be subject to greater scrutiny and oversight. These results are generally robust when we consider alternative earnings management measures.