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Earnings Management Behaviors Under Different Economic Environments: Evidence from Japanese Banks

This paper investigates Japanese banks' earnings management behavior under three distinct economic environments: (1) high-growth with asset price bubble economy (1985-1990); (2) stagnant growth with financial distress economy (1991-1996); and (3) severe recession with credit crunch economy (1997-1999). Using bank balance sheet information of 78 Japanese banks, we do not find that earnings management behavior by Japanese banks significantly differs across the three periods. Our results indicate that banks used security gains as a means to manage earnings throughout all three periods. We also find that banks used loan loss provisions to manage earnings; however, this behavior is only prevalent during two periods. Due to the fact that banks faced record-high non-performing loans during the latter severe recession period, banks on average may have been restrained from using loan loss provisions to smooth income and/or to replenish regulatory capital; instead, we detect that the Japanese banks lowered their lending.