Managerial ability and earnings management: the dark side of bank competition

Purpose The purpose of this study is to test whether managers with high ability use high or low discretionary accruals and the impact of competition on this relationship. Design/methodology/approach The study employs a sample of 114 EU banks over the period from 2006 to 2024. It analyzes the extent to which managers with varying levels of ability report discretionary loan loss provisions and how market competition influences these behaviors. Findings The results indicate that managers with high ability report fewer discretionary loan loss provisions compared to those with low ability, suggesting that more capable managers are less likely to manipulate reported income using these provisions. Additionally, the findings reveal that market competition negatively affects high-ability managers by prompting them to engage in earnings management practices to sustain their competitive edge. Practical implications These findings carry significant implications for EU bank regulators concerning the level of competition required to prevent opportunistic behavior and bank failures. Specifically, regulatory authorities should impose stricter controls on earnings management in competitive markets. Originality/value This study is the first to examine how managerial ability (MA) influences earnings management in the banking sector while considering the moderating role of market competition. By incorporating competition into the analysis, it shows how external pressure can shape managers' reporting choices. The study reveals that competition can alter the expected behavior of high-ability managers, leading them to use discretionary reporting when competitive pressure intensifies. This combined approach offers a new contribution to the literature and practical value for regulators in competitive banking environments.