Loan Loss Provision and Earnings Management: The Lawyers' Role in China

Abstract

IFRS 9 was issued to replace IAS 39 and overcome several matters that hindered IAS 39. Subjectivity and professional judgements delay from recognising loan loss provisions to facilitate earnings management practices and procyclicality. Prior studies have shown that earnings management has increased with the implementation of IFRS 9. This finding reflects the low disclosure quality related to financial instruments among banking industry firms. Lack of proper enforcement may result in limited compliance delivered by these banks. While the role of regulators in ensuring compliance is undeniable, the presence of legal officers and lawyers still play their role in ensuring high legal compliance, including compliance with the accounting standards. Using the panel data of 203 local Chinese banks from 2019 to 2022, this study examined whether the earnings management proxied by the correlation between loan loss provision and earnings before tax and provision has increased after IFRS 9 adoption. An analysis was also conducted to identify whether the lawyers’ ratio moderates the relationship between IFRS 9 adoption and earnings management. The results indicate that earnings management has increased after adopting IFRS 9, which aligns with previous studies. The results showed that the lawyer's number negatively moderates the relationship between IFRS 9 adoption and earnings management. Findings from this study indicate that lawyers are more critical in constraining earnings management in the IFRS 9 era. We believe the current study extends the existing knowledge by comprehending the effects of IFRS 9 on earnings management in a developing country's legal context. It provides insights into the dynamics of interplay between IFRS 9, earnings management, and legal systems.