Government ownership and bank income smoothing. Does politics matter?

This paper uses a new dataset to reassess the relationship between government ownership and income smoothing of commercial banks. We also evaluate how political connections vary the impact of government ownership on earnings management. We find that banks with more presence of state-controlled shareholders located in developing countries tend to have more incentives to engage in income smoothing. The paper finds no significant differential in earnings manipulation between government-controlled and non-government banks located in developed countries. Next, in order to investigate whether the income smoothing behavior of state-controlled banks is driven by political objectives, we test whether this behavior widens during national election years; we find strong support for this conjecture. The magnitude of the income smoothing behavior also varies with different countries and electoral characteristics. These findings suggest that the political channel plays an important role in determining the income smoothing incentives of state-controlled banks, especially in developing countries.

We use an international bank sample from the BankScope database with more than 13,889 bank-year observations in 78 countries over the period 2003–2012. Our results indicate that, compared with non-government ownership, majority government ownership is associated with higher levels of earnings management incentives. In particular, we find evidence that banks with more state-controlled shareholders tend to have a higher degree of income smoothing behavior, although the direction is not statistically significant in developed countries where the accounting disclosure and supervisory systems are better. More interestingly, our results in developing countries also document that government connected banks tend to have more income smoothing incentives during the national elections.