Loan Collateral and Accounting Conservatism

Abstract

We examine the relation between the use of collateral and accounting conservatism for a sample of Chinese firms during 2001 to 2006. China provides a powerful setting for testing the direct effect of accounting conservatism on collateral requirements because of the government’s tight control over interest rates during our sample period, which severely limits lenders’ use of loan pricing (through interest rates) to differentiate across borrowers with different risks. We document that accounting conservatism and the use of collateral are negatively related, after controlling for firm performance and risk. The negative relation is consistent with collateral and accounting conservatism being used as substitute mechanisms to reduce the agency cost of debt. Further analyses reveal that the substitutive relation is attenuated by borrower and lender state ownership. These results are consistent with our hypotheses that the marginal benefit of accounting conservatism, as reflected in reduced collateral requirements, is less pronounced for state-owned enterprises and for firms that obtain more loans from state-owned banks.

Keywords: Loan Collateral, Accounting Conservatism, Debt Contracting, State-Owned Enterprises, State-Owned Banks

JEL Classification: G21, M41