Insider Lending, Conservatism, and Accounting Standards
39 Pages Posted: 27 Mar 2014 Last revised: 21 Jun 2017
Date Written: June 20, 2017
Private firms often rely on insider lending, e.g. by banks. Insider lending is based on lending relationships that typically involve intertemporal loan pricing: losses from early years are recovered by information rents in later years, stemming from private information the inside lender has regarding the firm's creditworthiness. Our model shows that overly transparent financial reporting reduces the inside lender's information rent such that the lender has an insufficient incentive to offer early stage financing. Conservative reporting often is more effective to enable relationship lending than aggressive reporting. This paper thus offers a new rationale for why financial reporting by private firms is conservative and opaque. It also shows when accounting standards help firms to credibly commit to sufficiently conservative and opaque financial reporting.
Keywords: accounting conservatism, financial reporting opacity, private firms, insider lending, relationship lending
JEL Classification: G21, G32, M41
Suggested Citation: Suggested Citation