Vice or virtue? The impact of earnings management on bank loan agreements

Young Sang Kim, Yura Kim, Ha Chin Yi

Research output: Contribution to journalArticlepeer-review

6 Scopus citations

Abstract

This study investigates the implications of earnings management on corporate loan pricing. Through two competing hypotheses (smoothing hypothesis and managerial opportunism hypothesis), we find that both accruals and real activities management are associated with higher loan spreads. Banks view earnings management as a value-destroying process that hampers a borrower's capacity to repay a loan. Therefore, banks demand a marginal increase in loan spread to compensate for future uncertainty and monitoring costs. Furthermore, we examine the cross-sectional effects of lender reputation and lending relationship. Reputable and relationship banks demand even larger spreads for earnings management, consistent with them identifying and viewing earnings management as a risk-increasing activity. Additional analyses on simultaneity, loan contracting fees, covenant restrictiveness, and propensity matching method show consistent results.

Original languageEnglish
Pages (from-to)303-324
Number of pages22
JournalInternational Review of Economics and Finance
Volume73
DOIs
StatePublished - May 2021

Keywords

  • Abnormal
  • Accounting information quality
  • Costs of debt
  • Earnings management
  • Real activities management
  • Syndicated bank loan

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