TRANSMISSION OF REPORTING CONSERVATISM : FROM BANKS TO BORROWING FIRMS

Abstract

Using a sample of 6,424 U.S. banks, this paper empirically delineates the consequences of banks’ reporting conservatism regarding loan loss provisioning on borrowers’ financial reporting behavior. I find that reporting conservatism of banks regarding loan loss provisioning positively correlates with borrowing firms’ accounting conservatism, suggesting that reporting conservatism transmits from banks to their clients. Moreover, I find that information asymmetry strengthens the transmission, which is in accordance with the importance of accounting information in mitigating information problems between lenders and borrowers. On the contrary, relationship lending is found to weaken the transmission process, and this effect dominates even when interacting with the effect of information asymmetry. This implies that soft information gathered by banks can substitute for hard accounting information of borrowers. In addition, I do not find evidence that banks’ reporting conservatism leads to overinvestment or underinvestment of borrowers. Overall, my results suggest that banks’ reporting behaviors can have significant impacts on client firms’ financial reporting behaviors. And soft information gathered by banks from prior lending relationship can substitute for the hard accounting information requested from clients. It also contributes to the studies on the importance of relationship banking in mitigating information asymmetry problems.