Determinants of Earnings Management Using Discretionary Components of the Loans and Investments Portfolios of Banks: The Case of Saudi Arabia

This study aimed to examine whether banks in Saudi Arabia use allocations for loan losses in managing earnings as this study conducted on all banks registered on the Saudi Stock Exchange during the period from 2013-2022. The study also aims to determine the impact of the discretionary component of allocations for loan losses on both profitability metrics and market metrics. To achieve the objectives of the research, two metrics were used for earnings management. The first metric uses both the discretionary components of allocations for loan losses and realized gains and losses of investment portfolios. The second metric uses only the discretionary component of allocations for loan losses. The study used the quantitative analysis approach with regression and correlation models to test search hypotheses and answer research questions. The results of the first metric of earnings management indicate that the determinants of earnings management in banks are the financial leverage; total assets; net operating profit before taxes and zakat and loan provision; GDP growth rate and loan portfolio components. While the capital adequacy ratio is not one of the determinants of earnings management. The results of the second metric of earnings management indicated that the discretionary component of allocations for loan losses has positive impacts on the return on assets, return on equity, earnings per share, share price and annual share returns. That is, investors realize that allocations for loan losses included a discretionary component that will be converted into future earnings and cash flows, and they look at that component positively. According to the signal theory, the sample banks used loan allocations to transmit a positive signal about the levels of profits in the future. The results of this study have significant implications on the decisions of investors, supervisory authorities, bank managers and external auditors