The Role of Bank Reputation in “Certifying” Future Performance Implications of Borrowers’ Accounting Numbers

Authors


  • Accepted by Phil Berger. We thank the editor, an anonymous reviewer, Dan Amiram, Ray Ball, Ryan Ball, Douglas Diamond, Merle Erickson, Rich Frankel, Christian Leuz, Michael Minnis, David Ross, Florin Vasvari, Jieying Zhang, and participants at the 2010 Dopuch Conference at Washington University, the 2010 Duke/UNC Fall Camp, 2010 Financial Economics and Accounting Conference at the University of Maryland, the 2010 Stanford Summer Camp and seminar participants at Indiana University, Tsinghua University, and the University of Texas at Dallas for helpful comments. We thank the Thomson Reuters Loan Pricing Corporation for providing loan data. We gratefully acknowledge the financial support of the Kenan-Flagler Business School, The University of North Carolina at Chapel Hill, and the University of Chicago Booth School of Business. Regina Wittenberg-Moerman also gratefully acknowledges the financial support of the Neubauer Family Fellowship.

ABSTRACT

We investigate the role played by the reputation of lead arrangers of syndicated loans in mitigating information asymmetries between borrowers and lenders. We hypothesize that syndications by more reputable arrangers are indicative of higher borrower quality at loan inception and more rigorous monitoring during the term of the loan. We investigate whether borrowers with more reputable lead arrangers realize superior performance subsequent to loan origination relative to borrowers with less reputable arrangers. We further examine whether certification by high-reputation lead banks extends to the quality of borrowers’ reported accounting numbers. Controlling for endogenous matching of borrowers and lead banks, we find that higher bank reputation is associated with higher profitability and credit quality in the three years subsequent to loan initiation. We also show that bank reputation is associated with long-run sustainability of earnings via higher earnings persistence, and debt contracting value of accounting via a stronger connection between pre-loan profitability and future credit quality. We further document that the enhanced earnings sustainability associated with higher reputation lead banks reflects both superior fundamentals and accruals more closely linked with future cash flows.

Ancillary