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
January 25, 2016
Chicago Booth Research Paper No. 13-75
Theory offers competing predictions about the use of financial statements as a monitoring device in debt contracting. We use a proprietary dataset which records banks’ ongoing requests of information from small commercial borrowers after loan origination to examine these theories. We find banks request financial statements for half the loans and this variation is related to borrower credit risk, relationship length, collateral, and the provision of business tax returns, but in complex ways. The relation between borrower risk and financial statement requests has an inverted U-shape; and tax returns can be both substitutes and complements to financial statements, conditional on borrower characteristics and the degree of bank-borrower information asymmetry. Frequent financial reporting is used to monitor collateral, but only for non-real estate loans and only when the collateral is easily accessible to lenders. Collectively, our results provide novel evidence of a fundamental information demand for financial reporting in monitoring small commercial borrowers and a specific channel through which banks fulfill their role as delegated monitors.
Number of Pages in PDF File: 75
Keywords: Loan monitoring, financial contracting, collateral, debt contracts, relationship lending, tax returns, credit risk, banks
JEL Classification: G21, G24, G28, G32, H25, H32
Date posted: September 19, 2013 ; Last revised: January 26, 2016
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