Strategic Usefulness of Ignorance: Evidence from Income Smoothing via Retained Interest of Securitized Loans

Review of Quantitative Finance and Accounting, Volume 56, pp. 245-272, 2021

44 Pages Posted: 24 Oct 2020 Last revised: 1 Mar 2021

See all articles by Emre Kilic

Emre Kilic

University of Houston - C. T. Bauer College of Business

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business

Tharindra Ranasinghe

American University

Lin Yi

University of Houston, Clear Lake

Date Written: September 5, 2020

Abstract

This paper examines the notion of strategic ignorance in an earnings management context. Managers possess less information about loans subjected to securitization and auditors are aware of this shortcoming. Consistent with managers exploiting their own ignorance strategically and using loan loss provisions (LLP) of retained seller’s interest of securitized loans (SIL) more for earnings management than LLP of other loans, we find the use of LLP for income smoothing to be greater for banks that hold SIL. Moreover, the propensity to smooth income via LLP is increasing in the ratio of SIL to total loans. We also find that SIL is particularly useful for income smoothing in the fourth quarter, when greater auditor scrutiny makes it more difficult to manage earnings via LLP of non-securitized loans.

Keywords: Strategic ignorance, Income Smoothing, Loan loss provisions, Securitization, Seller’s interest loans

Suggested Citation

Kilic, Emre and Lobo, Gerald J. and Ranasinghe, Tharindra and Yi, Lin, Strategic Usefulness of Ignorance: Evidence from Income Smoothing via Retained Interest of Securitized Loans (September 5, 2020). Review of Quantitative Finance and Accounting, Volume 56, pp. 245-272, 2021, Available at SSRN: https://ssrn.com/abstract=3687113 or http://dx.doi.org/10.2139/ssrn.3687113

Emre Kilic

University of Houston - C. T. Bauer College of Business ( email )

Department of Accountancy & Taxation
4800 Calhoun Road
Houston, TX 77204
United States
(713) 743-4795 (Phone)
(713) 743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/Directory/profile.asp?search=Emre%20Kilic

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4838 (Phone)
713-743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/acct/acctprofile.asp?search=Gerald%20Lobo

Tharindra Ranasinghe

American University ( email )

United States

Lin Yi (Contact Author)

University of Houston, Clear Lake ( email )

2700 Bay Area Blvd. Box 42
Houston, TX 77058
United States

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