Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans
University of Chicago - Booth School of Business
Massachusetts Institute of Technology (MIT) - Sloan School of Management
February 1, 2015
Chicago Booth Research Paper No. 13-75
We examine when banks use financial statements to monitor small commercial firms. Theoretical research offers competing predictions surrounding the use of financial statements as a monitoring device in such settings where reporting between firms and banks is not mandated. Using a proprietary dataset of bank information requests after loan initiation, we examine these predictions and find that financial statements are requested for only half of the loans in the sample. This variation is mediated by borrower credit risk, contracting mechanisms, such as collateral, and alternative information sources, such as tax returns. However, the relations we identify are not straightforward — the relation between borrower risk and financial statement requests is nonlinear and financial statements can be both substitutes and complements to the alternative mechanisms. Collectively, our results provide novel evidence of the fundamental demand for financial reporting in the small commercial loan market and the manner in which banks fulfill their role as delegated monitors.
Number of Pages in PDF File: 50
Keywords: loan monitoring, financial contracting, collateral, debt, relationship lending, taxes
JEL Classification: G21, G24, G28, G32, H25, H32
Date posted: September 19, 2013 ; Last revised: February 11, 2015
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