Financial Reporting Differences and Debt Contracting

• In Event: Debt Financing and Debt Contracting

Abstract

I examine the relationship between contracting parties’ familiarity with one another’s accounting information and the terms and structure of debt contracts. I use the differences in generally accepted accounting principles (GAAP) among contracting parties domiciled in different countries as a proxy for how familiar a lending bank will be with a borrower’s accounting information. I find that a larger difference between the GAAP of the lender and the GAAP of the borrower is associated with a higher credit spread and higher fees. I also find that a larger difference between the GAAP of the lender and the GAAP of the borrower is associated with a more concentrated loan syndicate, suggesting a closer monitoring relationship between the borrower and the lender. Finally, I find that when there is a larger difference between the GAAP of the lender and the GAAP of the borrower, banks are no more or less likely to rely on financial covenants as a contracting tool. However, they tend to alter the types of covenants they write, relying more on capital-based financial covenants and less on earnings-based covenants. My results are consistent with banks experiencing information problems when contracting with parties whose accounting information they find to be unfamiliar. These results provide new evidence on the importance of financial reporting for debt contracting.

Author

• Anna Bergman Brown, Baruch College–CUNY