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Strategic usefulness of ignorance: evidence from income smoothing via retained interest of securitized loans

Author

Listed:
  • Emre Kilic

    (University of Houston)

  • Gerald Lobo

    (University of Houston)

  • Tharindra Ranasinghe

    (American University)

  • Lin Yi

    (University of Houston – Clear Lake)

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.

Suggested Citation

  • Emre Kilic & Gerald Lobo & Tharindra Ranasinghe & Lin Yi, 2021. "Strategic usefulness of ignorance: evidence from income smoothing via retained interest of securitized loans," Review of Quantitative Finance and Accounting, Springer, vol. 56(1), pages 245-272, January.
    • Handle: RePEc:kap:rqfnac:v:56:y:2021:i:1:d:10.1007_s11156-020-00892-y
    DOI: 10.1007/s11156-020-00892-y
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    1. Moritz Sefried & Jan Riepe, 2023. "The benefits of banks’ IT investments in times of trouble: evidence from loan loss accruals during the COVID-19 pandemic," Journal of Business Economics, Springer, vol. 93(1), pages 149-171, January.

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    More about this item

    Keywords

    Strategic ignorance; Income smoothing; Loan loss provisions; Securitization; Seller’s interest loans;
    All these keywords.

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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