Bank Lending Decisions and the Value Effect of Loan Announcements: New Evidence from the Sensitivity between Bank Loans and Firm Performance Adjusted for Earnings Management in China

Abstract

This paper explores the puzzle of inconsistent findings in regard to bank lending decisions and the negative response to bank loan announcements in China. Using firm performance before and after the lending decisions, adjusted for the effects of earnings management, we are able to examine not only whether banks pay attention to borrowers’ reported accounting profitability but also their credibility. We find that, when firm performance is adjusted for the effects of earnings management, in some cases it is no longer related to bank loan size. Specifically, the positive relationship disappears for loans by (state-owned banks) SBs to (state-owned enterprises) SOEs and loans by (small and medium banks) SMBs to both SOEs and non-SOEs, but still holds for loans by (foreign banks) FBs to both SOEs and non-SOEs. In regard to the market reaction to bank loan announcements, we find that negative bank loan announcements occur when the positive relationship between bank loan and firm performance disappears. Our evidence suggests that, in emerging markets, the positive relationship between firm performance and bank loan size is in some cases merely cosmetic and banks do not always exert an effort to screen borrowing firms. Accordingly, without real effort devoted to screening activities, banks lose the certification value on borrowers. Our study complements previous studies that use the sensitivity between firm performance and bank loan size to model bank lending decisions, and reconcile the conflicting evidence from the literature on banks’ informational role and the literature on bank lending decisions.

Keywords: Bank loans; Lending decisions; Earnings management; Announcement of bank loans; SOEs and non-SOEs; China

JEL Classification: G20; G21; G32; M40