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

Authors

  • TODD A. GORMLEY,

    1. The Wharton School, University of Pennsylvania
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  • BONG HWAN KIM,

    1. The Wharton School, University of Pennsylvania
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  • XIUMIN MARTIN

    1. Olin Business School, Washington University in St. Louis. We would like to thank the editor, Philip Berger, the anonymous referee, Anne Beatty (discussant), Mark Bradshaw (discussant), Rich Frankel, Radhakrishnan Gopalan, Bob Holthausen, Christian Leuz, Tara Rice (discussant), Cathy Schrand, and seminar participants at the American Finance Association 2010 annual meeting, NBER Corporate Finance Program Fall 2009 Meeting, Financial Intermediation Research Society 2009 Annual Meeting, FARS Mid-Year Meeting 2010, 2010 Global Issues in Accounting Conference, University of Chicago (Booth), Washington University in St. Louis (Olin), and the Wharton junior faculty lunch. Bong Hwan Kim acknowledges financial support from American University and the Center for Research in Economics and Strategy (CRES) in Washington University in St. Louis. The Prowess data set used in this paper was provided by the IMF through its visiting scholars program. The analysis and conclusions in this paper, however, are our own and do not necessarily represent those of the IMF or IMF policy. All remaining errors and omissions are our own.
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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.

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