Bank Competition and Borrower Conservatism

Abstract

We study the influence of bank competition on U.S. public borrowers’ accounting conservatism by exploiting the staggered adoption of the Riegle-Neal Interstate Banking and Branching Efficiency Act (IBBEA) of 1994, which increased the threats of new bank entrants and actual bank entry. We find that borrowers’ conditional conservatism fell after IBBEA. Conservatism fell more for firms located in states with weak incumbent banks and states with more out-of-state entrants, especially entrants with better monitoring technologies. The decrease in conservatism partially stems from borrowers’ increased investment and risk-taking incentives. Conservatism fell more for firms relying more on bank loans, especially those that borrowed loans for the first time after IBBEA, and firms having lower dedicated institutional ownership and board independence. We also find that loans included fewer covenants and that bank loan borrowers became less likely to choose Big N auditors and industry specialist auditors after IBBEA.

Keywords: bank competition, threat of new entrants, Interstate Banking and Branching Efficiency Act (IBBEA), conditional conservatism, loan contracting, loan covenant

JEL Classification: G21, G28, M41, K23