The Effect of Governance on Credit Decisions and Perceptions of Reporting Reliability

Abstract

We conduct an experiment to assess lenders' evaluation of board strength when making lending judgments and evaluating the reliability of financial reports. Our participant pool consists of 62 professional lenders whom we ask to make credit decisions and evaluate reporting reliability on an experimental basis. We predict that governance strength and perceived reliability affect lending decisions. We find that lenders are primarily sensitive to financial condition and the perceived reliability of financial reporting. While we also find that lenders are sensitive to board strength, further tests suggest lenders appear particularly sensitive to board strength only for relatively high-performing firms. Underperforming firms do not appear to be able to increase their chances of receiving a loan if they have a strong board. We also find that the perceived reliability of the financial reports does not appear to be affected by board strength or by the applicant's financial condition. The paper discusses implications for policy making, practice, and re-search.

Keywords: governance, experiment, credit decision, reporting quality

JEL Classification: C91, F39, G21, G30, M40