Organizational Memory and Bank Accounting Conservatism – EAR

Posted by ARC Commitee - Nov 22, 2020

This paper is the first to examine the impact of organizational memory of banks on the conservatism of accounting policy. Specifically, we examine the organizational memory of banks regarding bad times history. We separately address two related questions: 1) In the face of bank-level or macro-level crises, how can bank managers and/or the board of directors take action to change bank accounting policy? 2) Is the change of accounting policy driven by managers and board monitoring (either or both), or auditors? We show both theoretically and empirically that the bad time memory of the managers and board of directors, rather than that of the external auditors, is mainly responsible for heightened accounting conservatism.  

            Our results show that bad times, either bank-specific or economy-wide, are associated with increased bank accounting conservatism. In other words, banks that have been undercapitalized and/or witnessed other banks fail in an economic crisis recognize their own losses more timely and recognize proportionately larger loan loss allowances. These findings support the prediction that, relative to healthy banks, banks that have survived crises might overreact to their bad times and become more pessimistic about their future.  

In order to confirm our empirical results from path analysis that the bad time memories of managers and boards of directors rather than those of external auditors is mainly responsible for the heightened accounting conservatism, we conduct a survey among senior U.S. bank executives (i.e., CEO, CFO, president, and chairman) to obtain corroborative anecdotal evidence/testimonies and identify which force plays the major role in impacting the relationship between memory of bad times and bank accounting conservatism. The responses from the survey participants generally confirm our findings that the bad time memories of managers and boards of directors are the most important forces heightening bank accounting conservatism. The survey responses also provide evidence that the bad time memories of auditors can heighten bank accounting conservatism but with less impact.