Horizon Problem and Earnings Management in the Banking Sector.

Abstract

This study examines the horizon problem and earnings management in the American banking sector, focusing on retiring CEOs. Analyzing data, from 602 banks and 5,658 firm-year observations from 1996 to 2022, the research assesses the impact of CEO turnover on loan loss provisions. The findings indicate that loan loss provisions are not significantly affected by the performance-based pensions, lump sum options, external CEO appointments, gender, clawback policies, or extended board tenure post-retirement in the CEO’s final year of tenure. However, CEO power significantly increases earnings manipulation in the CEO's final year. Earnings management increases when a new CEO joins post-publication of financial reports and decreases with pre-publication appointments. These insights highlight the need for robust corporate governance in the banking sector.