Research On The Influence Of CEO Overconfidence On Loan Loss Provisioning

The loan loss provision is the dominant accrual for banks.The main function of loan loss provisioning is to cover the expected credit loss to enhance the risk defense ability of banks and alleviate the information asymmetry between banks and stakeholders.In the global financial crisis of 2008,the loan loss accounting based on the Incurred Loss Model has been criticized for its pro-cyclical effects.After the financial crisis,major accounting standard setters around the world replaced the Incurred Loss Model with the Expected Loss Model.Compared with the Incurred Loss Model,the most important change in the Expected Loss Model is to give the management of banks greater discretion,so that loan loss provisioning can be timelier.Although banks were required to use the Incurred Loss Model to estimate loan losses,the complexity of loan portfolios gave the management of banks substantial discretion.Given that loan losses are estimated by managers ' professional judgment,it can be reasonably expected that executives' overconfidence may have a material impact on provisions for loan losses.Based on financial accounting theory,risk management theory and overconfidence theory,using a sample of Chinese A-share listed commercial banks from 2003 to 2014,this paper examines the relationship between CEO overconfidence and loan loss provisioning.Empirical results show that overconfident CEOs recognize lower loan loss provisions compared to other CEOs,and the negative effect of CEO overconfidence on loan loss provisioning is greater for banks which face greater uncertainty.Channel analysis further suggests that the negative relationship between CEO overconfidence and loan loss provisioning is partly driven by overconfident CEOs' low sensitivity to expected loan losses,which results in delayed expected loss recognition.The conclusion of this paper is important in theory and practice.The main contribution of this paper is to include CEO overconfidence into the framework of the study on loan loss provisioning,which provides a possible and reasonable explanation for delayed loan loss recognition.This paper may provide an important inspiration for the relevant policy-makers and regulatory authorities.In order to mitigate the pro-cyclical effect that may be caused by delayed expected loan loss recognition,accounting policy-makers and financial regulatory authorities should not only optimize the loan impairment model,but also strengthen accounting supervision and prudent regulation in order to avoid the negative impact of irrational tendencies of managements on loan loss provisioning.