Zombie Lending, Financial Reporting Opacity and Contagion

Abstract

Using a novel dataset of listed firms in Japan, we find that bank lending to zombie (insolvent) borrowers induces these borrowers to manipulate earnings. Such an effect is more pronounced when the lending is from borrowers? main banks or for longer term loans, suggesting a complicity of informed banks in earnings manipulations. We overcome the endogeneity concern using a natural experiment arising from capital injections into banks instituted by the Japanese Government in the late 90?s and find a consistent result. Further, we examine the industry spillover (contagion) effect of such accounting manipulation and find that profitable firms adopt more opaque reporting when the industry is dominated by zombie firms. Overall, our results suggest that keeping insolvent borrowers afloat deteriorates the information environment of both zombie firms and their profitable industry peers.