Bank Relationships, Earnings Quality and Cost of Debt: Cross-Country Evidence on Private Firms

55 Pages Posted: 19 Dec 2019

See all articles by Jochen Bigus

Jochen Bigus

Free University Berlin, Department Accounting and Finance

Christa Hillebrand

Free University of Berlin (FUB)

Aline Grahn

Free University of Berlin (FUB)

Date Written: April 2019

Abstract

We expect that private firms choose a close relationship with a bank – often based on private information – in order to save on direct or proprietary costs of disclosure. For a large sample of bank relationships in 12 European countries, we find evidence that close bank relationships are associated with lower earnings quality as measured by higher absolute discretionary accruals and less timely loss recognition. This effect is stronger for firms with high proprietary costs. Further, we find that the strength of creditor rights intensifies the link between close bank relationships and earnings quality, while tax-book conformity moderates it. Finally, we show that close bank relationships directly tend to decrease the borrowing firms’ cost of debt by about 40 basis points on average. Indirectly, the cost of debt increase, because relationship lending goes along with lower earnings quality and relationship banks charge higher interest rates for poorer earnings quality than do other lenders. The findings suggest that relationship lending and financial disclosures can be considered as substitutes and that this relation is affected by the institutional framework. The paper also highlights that relationship lending implies a direct negative and an indirect positive effect on the borrowing firm’s cost of debt.

Keywords: Bank relationships, Private firms, Financial reporting quality, Creditor protection, Cross-country study

JEL Classification: G21, G32, M41

Suggested Citation

Bigus, Jochen and Hillebrand, Christa and Grahn, Aline, Bank Relationships, Earnings Quality and Cost of Debt: Cross-Country Evidence on Private Firms (April 2019). Available at SSRN: https://ssrn.com/abstract=3498335 or http://dx.doi.org/10.2139/ssrn.3498335

Jochen Bigus (Contact Author)

Free University Berlin, Department Accounting and Finance ( email )

Van't-Hoff-Str. 8
Berlin, Berlin 14195
Germany
++49-30-83852509 (Phone)

Christa Hillebrand

Free University of Berlin (FUB) ( email )

Van't-Hoff-Str. 8
Berlin, Berlin 14195
Germany

Aline Grahn

Free University of Berlin (FUB) ( email )

Van't-Hoff-Str. 8
Berlin, Berlin 14195
Germany

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