Does Relationship Lending Require Opaque Financial Reporting?

• In Event: Financial Accounting Theory

Abstract

For many private firms, relationship lending is the only viable form of outside financing. Relationship lending frequently relies on intertemporal loan pricing: losses from adverse selection in early years are compensated by information rents in later years. Information rents are based on the lender’s access to the debtor firm’s private information.
Our model shows that too transparent financial reporting reduces the relationship lender’s information rent too much such that there is no finance in the first place. During financial distress, private firms also find it easier to get liquidity support from relationship lenders when financial reporting is sufficiently opaque. Conservative opacity is more suitable to enable relationship lending than aggressive reporting systems.
The paper contributes to explain why private firm’s financial reporting is (conservatively) opaque and raises concerns whether recent regulatory efforts to improve private firm’s transparency might have undesirable side effects.

Authors

• Jochen Bigus, Freie Universität Berlin

• Hendrik Hakenes, University of Bonn