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Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans

75 Pages Posted: 19 Sep 2013 Last revised: 2 Jun 2016

Michael Minnis

University of Chicago - Booth School of Business

Andrew Sutherland

Massachusetts Institute of Technology (MIT) - Sloan School of Management

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Date Written: May 31, 2016

Abstract

Using a dataset which records banks’ ongoing requests of information from small commercial borrowers, we examine when banks use financial statements to monitor borrowers after loan origination. 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.

Keywords: Loan monitoring, financial contracting, collateral, debt contracts, relationship lending, tax returns, credit risk, banks

JEL Classification: G21, G24, G28, G32, H25, H32, M40, M41

Suggested Citation

Minnis, Michael and Sutherland, Andrew, Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans (May 31, 2016). Chicago Booth Research Paper No. 13-75. Available at SSRN: https://ssrn.com/abstract=2327378 or http://dx.doi.org/10.2139/ssrn.2327378

Michael Minnis (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

Andrew Sutherland

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street

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