Relationship Lending and Conservative Accounting? Empirical Evidence from Private Firms

Abstract

This is the first study which analyzes the effect of relationship lending on accounting conservatism for private firms, and how this affects corporate finance. Based on a database containing the financial accounting data of approx. 8,600 private German firms, we first show that relationship lending is positively associated with the level of accounting conservatism, even when controlling for leverage and other factors. Relationship lending is measured by the proportion of loans provided by the main lender. Accounting conservatism is proxied by cumulative non-operating accruals and a novel conservatism score, both of which tend to considerably reflect unconditional conservatism. Second, we find that the cost of debt increases with the level of accounting conservatism. Third, we observe that relationship lending positively affects the amount of trade credit. Suppliers seem to interpret the existence of a lending relationship as an indication of a firm's creditworthiness. The results suggest that unconditional conservatism goes hand in hand with lending relationships even controlling for taxation issues. Our findings match the theoretical literature on implicit lending contracts. This literature claims that relationship lenders attempt to retain superior information to realize information rents that compensate for losses when lending to young firms and to firms in financial distress. Unconditional accounting conservatism may be used as a tool to retain superior information and to enhance implicit contracting.