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
Date Written: September 5, 2020
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: Suggested Citation