Do Banks in Saudi Arabia Manage Earning Using Discretionary Components?

Abstract

This study aimed to examine whether banks in Saudi Arabia used discretionary components for loan and investment portfolios in managing earnings as this study was conducted on all banks registered on Saudi Arabia Stock Market (TASI) for the period 2013-2022. The study also aimed to determine the impact of the discretionary component of the allocations for loan losses on both profitability metrics and market metrics. To achieve objectives of the study, two metrics were used as proxies for managing earnings. The first metric used both the discretionary components of the allocations for loan losses and the realized gains and losses of investment portfolio. The second metric used only the discretionary component of the allocations for loan losses of the credit portfolio. The study relied on the quantitative approach as the study used regression models and correlations to test the study’s hypotheses.  The results of the first metric of earnings management indicated that the determinants of earnings management were financial leverage, total assets, net operating profit, GDP growth rate, while the capital adequacy ratio was not one of the determinants of earnings management. The results of the second metric of earnings management indicated that the discretionary component of the allocations for loan losses had positive impacts on return on assets, return on equity, earnings per share, share price and annual share returns. That is, investors realized that the allocations for loan losses contained a discretionary component that will be converted into future earnings and cash flows, and investors look at the discretionary component positively. According to the signal theory, Saudi banks used the allocations for loan losses to transmit positive signals about the levels of the profits in the future. The results of this study have significant implications on the decisions of investors, supervisory authorities, bank managers and external auditors.