Changes in Contractual Environment and Borrower Reporting Quality – An Empirical Study of Chinese Bank Privatization

• In Event: Debt contracting and financial reporting

Abstract

How do changes in the contractual environment between firms and their capital providers influence those firms’ financial reporting quality (FRQ)? We examine this question by investigating how Chinese stated owned bank (CSB) privatization affects the quality of borrowers’ financial statements. Using a difference-in-difference research design which compares changes in CSBs issuing IPOs with changes in CSBs that did not issue an IPO, we find that bank-lending terms, including loan maturity, guarantee requirement, and interest rate became more sensitive to borrower return on assets (ROA) after a bank IPO. We also find that after their lending banks issue IPOs, various measures of borrowers’ accounting quality improve. Further analysis reveals that the improvements in borrower reporting quality are more pronounced for those IPO-issuing banks that exhibit a greater post-IPO increase in the sensitivity of loan terms to borrower performance. These results suggest that 1) CSBs increased reliance on borrowers’ ROA for setting loan terms post privatizations; 2) such contractual environment change likely contributes to the improvement in the quality of the borrower financial statements. Our results are robust to controlling for confounding factors in the cross section and in the time series.

Authors

• Xiumin Martin, Washington University in St Louis

• Sugata Roychowdhury, Boston College

• Xuejiao Liu, University of International Business and Economics

• Dequi Chen, University of International Business and Economics