Commercial Lenders' Use of Accounting Information in Interaction with Source Credibility*

Abstract

AbstracLThe credibility of individual commercial bonowers, which lendeis refer to as "character,'' affects lenders' use of accounting information. This effect of source credibility is subtle compared to the effect of external andits on the use of financial statements in other contexts. It is hypothesized that accounting facts must be positive (supporting loan approval) for character facts to influence lenders' judgments and loan decisions. Character facts will not affect judgments or loan decisions significantly when accounting facts are negative (supporting loan denial). This accounting/character interaction is predicted to become stronger as lendeis gain experience and develop criteria for evaluating character. In an experiment, lenders read a loan application that contained facts concerning accounting, character, and other information; the accounting and character facts were manipulated to bie either positive or negative, resulting in four versions of the application. The lenders recommended approval or denial of the loan and estimated die likelihood that the loan would be fully repaid (a risk estimate). Interactive effects of accounting and character facts on lenders' loan decisions and risk estimates were found, but the accounting/character interactions generally did not vaiy with experience level. One notable difference was that experienced lenders never approved loans when accounting facts were negative, but inexperienced lenders sometimes did. This disagreement between lenders and their critics suggests that the credibility of sources of accounting information may be a more in^rtant factor in commercial lending than attestation by independent auditors. The puipose of this paper is to show that the use of accounting information in commercial lending depends on source credibility communication that is subtle compared to the role of independent audits in other contexts. Prior accounting research has concentrated on the use of attestation by external auditors to establish credibility of accounting infomiation, rather than source credibility (e.g., DeAngelo 1981; Palmrose 1988; Scott 1988). When source credibility has been discussed, it has been from the point of view of auditors when they deal with clients. For example, Ponemon and Gabhart (1993) found that auditors' level of ethical reasoning affects their sensitivity to competent, low-integrity management ("competent crooks"). The motivation and practical benefits of such research, however, involve reducing litigation and reputation effects that auditors may incur by becoming involved with noncredible clients. The significance of source credibility from the perspective of users of financial statements, such as commercial lenders, has not been established. In the increasingly competitive commercial loan market in the UnitedIn asserting that they conibine accounting and source credibility information in their loan judgments, lenders claim to use a relatively complex information processing strategy. Maines (forthcoming) states that it has proven difficult to s...

Banks' risk assessment of Swedish SMEs

“…The final decision is often made on a higher hierarchical level, depending on the amount and riskiness, from the local bank office committee to the banks headquarters. This is in contrast to recent developments in the UK, where banks have used credit scoring systems and centralized decision making to help overcome difficulties in assessing risk in small firm loan applicants (Deakins et al, 2004) Concerning the characteristics of the firm affecting the likelihood of receiving funding, an extensive literature review shows that information pertaining to the characteristics of the borrower typically deals with the general risk proclivity of the SME (Sargent et al, 1991;Scherr et al, 1993;Sinkey, 1992), the competence within the business project (Berggren, Lindström & Olofsson, 2001;Harhof & Körting, 1998;Hedeling & Sjöberg, 1993Petersen & Rajan, 1994); the CEO's personal experience (Beaulieu, 1994(Beaulieu, & 1996Cooper et al, 1989Cooper et al, & 1995Davidson & Honig, 2003;Hedelin, 1999;Jankowicz & Hisrich, 1987;Keasey & Watson, 1991;Pettit & Singer, 1985); the extent of strategic planning (Beaulieu, 1994(Beaulieu, & 1996Sinkey, 1992;Berger, 1997Berger, /1998Mintzberg & Waters, 1985;Matthews & Scott, 1995); and the past performance of the firm (Gibson 1993;Kam 1990;Altman 1983); Beaulieu, 1996;Berger & Udell, 1995;Deakins & Hussain, 1994;Tiermey & Truglio, 1997;Uzzi, 1999). For a review of previous research that discusses the use of these factors, the reader is referred to Table 1 in the appendix.…”

“…Third, in order to shift the risk from the bank to the borrower, they can ask for collateral (Bergström and Lennander, 1997;Anderson, 1999), or ensure that the financial standing of the borrower is solid enough to repay the loan should the project fail (Altman, 1983;Sinkey, 1992;Beaulieu, 1994Beaulieu, & 1996.…”

The impact of the new OHADA accounting system on the judgments and decisions of Cameroonian bankers

“…quality of management or the position of the firm within the industry (Beaulieu, 1994;Berry, Faulkner, Hughes, & Jarvis, 1993;Treacy & Carey, 1998;Viger et al, 2008). Collateral and the firm's repayment history in previous loan cases are also considered (Beaulieu, 1994;Berry et al, 1993;Kemp & Overstreet, 1990;Treacy & Carey, 1998). Financial statements are essential to analyzing the firm's capital structure, solvency, liquidity, and profitability/cash flow (Beaulieu, 1994;Berry et al, 1993;Treacy & Carey, 1998).…”

“…It also involves studying financial and non-financial characteristics, e.g. quality of management or the position of the firm within the industry (Beaulieu, 1994;Berry, Faulkner, Hughes, & Jarvis, 1993;Treacy & Carey, 1998;Viger et al, 2008). Collateral and the firm's repayment history in previous loan cases are also considered (Beaulieu, 1994;Berry et al, 1993;Kemp & Overstreet, 1990;Treacy & Carey, 1998).…”

“…This process requires weighing many factors, including firm-specific information and economic considerations (Beaulieu, 1994;Treacy & Carey, 1998). It also involves studying financial and non-financial characteristics, e.g.…”