[Prior research has found that loan loss provisions are positively associated with bank stock returns and future cash flows, conditional on less discretionary information about loan default. We find that these positive valuation implications obtain only for loan loss provisions for low regulatory capital banks in the fourth fiscal quarter. Our regulatory capital-based tests are motivated by the idea that increased discretionary loan loss provisions are plausibly good news only for banks which appear to have loan default risk problems based on prior information. Our fiscal quarter tests are motivated by findings in prior literature that suggest that managers have incentives to delay income decreasing accruals until the fourth quarter when the audit occurs, implying that income decreasing accruals are more likely, and therefore more expected, in the fourth quarter than in other fiscal quarters (Mendenhall and Nichols 1988; Boyd et al. 1994).]

Prior research shows that during the pre-1990 bust financially weak banks managed income upward by delaying provisions for losses on heterogeneous loans. In contrast, we predict and find that during the 1990s boom profitable banks managed income downward by accelerating provisions for losses on homogeneous loans. Profitable banks obscured their income smoothing by accelerating charge-offs of homogeneous loans and by recording more gross charge-offs to offset recoveries of previously charged-off loans. Over the three years subsequent to the acceleration of charge-offs, they had higher and more persistent income before provisions for loan losses than other banks, consistent with income smoothing over a prolonged horizon.

We hypothesize and provide evidence that characteristics of banks’ loan securitizations accounted for as sales determine the extent to which banks retain the risks of the securitized loans. We show that banks retain more risk when: (1) the types of loans have higher and/or less externally verifiable credit risk, (2) the loans are closed-ended and banks retain larger contractual interests in the loans, and (3) the loans are closed-ended and banks retain types of contractual interests that more strongly concentrate the risk of the securitized loans. We show that the magnitude and type of retained contractual interests are not risk-relevant in revolving loan securitizations, because banks have more incentive and ability to provide implicit recourse, a non-contractual interest.

Prior research has found that loan loss provisions are positively associated with bank stock returns and future cash flows, conditional on less discretionary information about loan default. We find that these positive valuation implications obtain only for loan loss provisions for low regulatory capital banks in the fourth fiscal quarter. Our regulatory capital-based tests are motivated by the idea that increased discretionary loan loss provisions are plausibly good news only for banks which appear to have loan default risk problems based on prior information. Our fiscal quarter tests are motivated by findings in prior literature that suggest that managers have incentives to delay income decreasing accruals until the fourth quarter when the audit occurs, implying that income decreasing accruals are more likely, and therefore more expected, in the fourth quarter than in other fiscal quarters (Mendenhall and Nichols 1988; Boyd et al. 1994).

We document that firms in more politically corrupt regions of China adopt more conservative accounting. The relation between local political corruption and accounting conservatism weakens after China’s anticorruption campaign launched in 2012 and in firms with a lower risk of expropriation by corrupt officials, stronger incentives to report earnings aggressively, or greater gains from corruption. Further analysis shows that accounting conservatism and alternative corporate strategies complement each other in shielding firms against corrupt officials’ expropriation of corporate resources. Our study provides novel evidence about an accounting approach used by firms in response to perceived political costs.