Working Paper: CEPR ID: DP9934
Authors: Jochen Bigus; Hendrik Hakenes
Abstract: For many private firms, relationship lending is the only viable form of outside financing. Relationship lending typically relies on intertemporal loan pricing: losses from early years are recovered by information rents in later years, which stem from the lender's private information regarding the firm's creditworthiness.Our model shows that overly transparent financial reporting reduces the relationship lender's information rent such that the lender has insufficient incentive to offer early stage financing as a result. During financial distress, private firms find it easier to obtain liquidity support from relationship lenders when financial reporting is sufficiently opaque. Conservative opacity enables relationship lending more effectively than aggressive reporting.This paper seeks to explain why private firm financial reporting is (conservatively) opaque and raises concerns regarding recent regulatory efforts that require private firms to engage in more transparent financial reporting because such efforts may result in undesirable side effects.
Keywords: Accounting; Conservatism; Financial Reporting; Opacity; Private Firms; Relationship Lending; Small and Medium Enterprises
JEL Codes: G21; G32; M41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sufficient opacity in financial reporting (G38) | relationship lending effectiveness (G21) |
| overly transparent financial reporting (G38) | diminishes information rent for relationship lenders (G21) |
| diminished information rent for relationship lenders (G21) | disincentivizes offering financing to private firms (G32) |
| disincentivizes offering financing to private firms (G32) | breakdown in the relationship lending process (G21) |
| conservative financial reporting (G38) | maximizes expected information rents for lenders (G21) |
| maximized expected information rents for lenders (G21) | incentivizes providing necessary financing (G32) |
| excessive opacity (Y20) | inefficient investment decisions (G11) |
| excessive opacity (Y20) | financing of nonviable projects (G32) |
| conservative reporting (P17) | welfare-optimal outcomes (D69) |