Changes in Lending Practices and Borrower Reporting Quality : Evidence from Chinese State Bank Privatizations

How do developments at lending institutions that alter the way they grant and monitor loans influence their borrowers' financial reporting quality (FRQ)? We examine this question by investigating the influence that privatizations of Chinese state banks (CSBs) had on the quality of their borrowers' financial statements. Using a difference-in-difference research design which compares changes in CSBs that issue Initial Public Offerings (IPOs) to those that do not, we find that bank-lending terms, including loan maturity, guarantee requirement, and interest spread, become more sensitive to borrowers' return-on-assets (ROA) after a bank's IPO. We also find that pursuant to the IPOs by their lending banks, various measures of borrowers' FRQ improve significantly. Further, the increase in FRQ is more pronounced for borrowers from those IPO-issuing CSBs whose loan terms exhibit a larger increase in sensitivity to borrowers' FRQ. These results suggest that post-privatization: (1) CSBs increase their reliance on borrowers' operating performance for setting loan terms; (2) this increased reliance contributes to an improvement in the quality of the financial statements that provide the performance measures. Cross-sectional analysis reveals that the increases in sensitivity of loan terms to borrower performance, as well as borrowers' FRQ are more pronounced for IPO-issuing CSBs experiencing a greater increase in board financial expertise or a greater decline in political connections following their IPOs