Bank Lending Standards and Borrower Accounting Conservatism

Abstract

Bank lending standards vary over time. Periods in which firms find it relatively easy to borrow are followed by periods in which banks scrutinize borrowers more and tighten lending. We predict that changes in lending standards affect the accounting conservatism of bank-dependent firms. Using (i) a natural experiment that leads to certain banks tightening lending standards for plausibly exogenous reasons and (ii) time series variation in economy-wide bank lending standards, we find that borrowers increase their asymmetric timely loss recognition in response to the tightening of lending standards. Further, riskier borrowers, borrowers less likely to violate loan covenants, and borrowers whose banks tighten lending standards to a greater extent display larger increases in conservatism following the tightening of lending standards. These results suggest that borrowers internalize the costs and benefits of increasing conservatism. Finally, borrowers do not seem to decrease conservatism immediately after the lending standards are loosened. Overall, our results illuminate a commonly observed banking phenomenon that can influence firms’ incentives to recognize losses, suggesting that developments in the banking sector can shape the information produced by firms in the real sector. This paper was accepted by Suraj Srinivasan, accounting.