Balancing acts: Bank market deregulation and the dynamics of earnings management

Abstract

This study examines the impact of bank market deregulation in U.S. since 1994 on corporate earnings management decision makings. We show that bank market deregulation has led to a trade-off between accrual-based earnings management and real earnings management. The trade-off is driven by the improved monitoring of banks since deregulation where banks pay more diligence to monitor accruals which are reverse in a short-term and more relevant to the default risk banks expose to. To respond, firms engage in more real earnings management which has a long-term impact on corporate performance but is less relevant to current default risk.