Do Firms Adjust Their Timely Loss Recognition in Response to Changes in the Banking Industry?

Abstract

This paper investigates the impact of changes in the banking sector on firms' timely recognition of economic losses. In particular, we focus on the entry of foreign banks into India during the 1990s, which likely causes an exogenous increase in lender demand for timely loss recognition. Analyzing variation in both the timing and the location of the new foreign banks' entries, we find that foreign bank entry is associated with more timely loss recognition and this increase is positively related to a firm's subsequent debt levels. The change appears driven by a shift in firms' incentives to supply additional information to lenders and lenders seem to value this information. The increase in timely loss recognition is also concentrated among firms more dependent on external financing: private firms, smaller firms, and nongroup firms. Overall, our evidence suggests that a firm's accounting choices respond to changes in the banking industry. AbstractThis paper investigates the impact of changes in the banking sector on firms' timely recognition of economic losses. In particular, we focus on the entry of foreign banks into India during the 1990s, which likely causes an exogenous increase in lender demand for timely loss recognition. Analyzing variation in both the timing and the location of the new foreign banks' entries, we find that foreign bank entry is associated with more timely loss recognition and this increase is positively related to a firm's subsequent debt levels. The change appears driven by a shift in firms' incentives to supply additional information to lenders and lenders seem to value this information. The increase in timely loss recognition is also concentrated among firms more dependent on external financing: private firms, smaller firms, and non-group firms. Overall, our evidence suggests that a firm's accounting choices respond to changes in the banking industry.

Accounting conservatism and firm investment efficiency

“…Therefore we add to a growing number of studies that demonstrate that accounting conservatism, through the timelier recognition of losses in the income statement, generates positive economic outcomes (Ahmed et al, 2002;Guay and Verrecchia, 2007;LaFond and Watts, 2008;Suijs, 2008;Wittenberg Moerman, 2008;Zhang, 2008;Khan and Watts, 2009;Göx and Wagenhofer, 2009;Francis and Martin, 2010;García Lara et al, 2011;Gormley et al, 2012;Ettredge et al, 2012;Jayaraman and Shivakumar, 2013). One interpretation of our evidence is that the elimination of conservatism from accounting regulatory frameworks may lead to undesired economic consequences.…”

The implications of research on accounting conservatism for accounting standard setting

“…Nikolaev (2010) finds that firms with more extensive use of debt covenants in public debt contracts exhibit higher levels of conditional conservatism. Gormley et al (2012) find that the entry of foreign banks into India was associated with an increase in conditional conservatism and that this increase was linked to subsequent increases in corporate debt levels. Other papers reporting evidence that debt contracting concerns drive conditional conservatism include Jayaraman (2012), Jayaraman and Shivakumar (2013) and Tan (2013).…”

Information Consequences of Accounting Conservatism

“…Contrary to this view, a significant body of academic research provides evidence that conservatism plays an important economic role in debt contracting, benefiting both lenders and borrowers (Ahmed, Billings, Morton, & Stanford-Harris, 2002;Ball, Robin, & Sadka, 2008;Beatty, Weber, & Yu, 2008;Wittenberg-Moerman, 2008;Gormley, Kim, & Martin, 2012;Göx & Wagenhofer, 2009Nikolaev, 2010;Zhang, 2008). This prior work shows that conservatism increases the debt-contracting value of accounting information and reduces information asymmetries between borrowers and lenders, and also, among lenders.…”