Accounting Credibility and Liquidity Constraints: Evidence from Reactions of Small Banks to Monetary Tightening

Abstract

ABSTRACTThis study examines the relationship between accounting credibility and firms' ability to fund their investments. Theory suggests that credible reporting resulting from external audits enables firms to attract external funds needed for their investments. The tests exploit monetary policy tightening that creates a liquidity shortage for banks, which, in turn, either requires banks to raise additional funds to restore liquidity or forces them to restrict their investments in the form of lending. Studying small non-public banks for which external audits are voluntary, I find that audited banks can better access funds during periods of monetary tightening than unaudited banks. As such, adverse liquidity shocks impede the lending of audited banks less. Overall, these findings present new evidence on how accounting credibility affects firms' ability to invest.Data Availability: The data are available from the sources indicated in the text.