The Effect of Bank Competition on Accounting Conservatism

• In Event: Various Topics in Accounting

Abstract

This study exploits the Riegle-Neal Interstate Banking and Branching Efficiency Act (IBBEA) as a natural experiment to investigate the impact of bank competition on firms’ accounting conservatism. Since the IBBEA allowed banks to expand across state borders and unambiguously increased bank competition, I predict that after the IBBEA firms possess greater bargaining power in debt contracting and have fewer incentives to report conservatively. Using a differences-in-differences research design, I find that firms’ financial reporting becomes less conservative following the IBBEA, and this effect is more pronounced in states with higher bank competition. I also find that the decrease in conservatism is less pronounced for firms with higher analyst coverage, and is more pronounced for firms with smaller size and higher likelihood of bankruptcy, implying that firms with weaker monitoring mechanisms and higher risks are more likely to take the advantage of the IBBEA to report less conservatively. My results are robust to using various time window size, alternative conservatism and return measures. In addition, I find that firms are given lower initial interest rates of bank loans initiated after the IBBEA, confirming that the IBBEA takes effect through the channel of debt contracting. Overall, my study suggests that bank competition plays a significant role in shaping corporate accounting conservatism.

Author

• Liya Hou, University of Texas at Dallas