Accounting Information and Risk Shifting with Asymmetrically Informed Creditors

52 Pages Posted: 19 Feb 2021 Last revised: 10 Nov 2023

See all articles by Tim Baldenius

Tim Baldenius

Columbia University - Columbia Business School

Mingcherng Deng

City University of New York (CUNY) - Baruch College

Jing Li

The University of Hong Kong - Faculty of Business and Economics

Date Written: October 31, 2023

Abstract

This paper explores the effects of public information such as accounting earnings in a competitive lending setting with risk shifting. Debt financing creates incentives for borrowers to take on excessive risks, in particular in bad states of the world. If a privately informed inside creditor bids against outside creditors to extend a loan, public information levels the playing field, which affects the bidding and risk shifting. Nonetheless, a perfect public signal would yield the least efficient outcome: introducing some measurement noise alleviates risk shifting by subjecting outside creditors to the winner's curse, allowing borrowers in bad states cheaper access to loans. However, for pessimistic priors about the borrower, greater public signal precision can alleviate risk shifting, at the margin. We discuss implications for financial reporting regulations along the business cycle and for creditor turnover.

Keywords: Asset substitution, risk shifting, relationship lending, creditor turnover, accounting information

JEL Classification: G20, G32, M41

Suggested Citation

Baldenius, Tim and Deng, Mingcherng and Li, Jing, Accounting Information and Risk Shifting with Asymmetrically Informed Creditors (October 31, 2023). Journal of Accounting & Economics (JAE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3750846 or http://dx.doi.org/10.2139/ssrn.3750846

Tim Baldenius

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Mingcherng Deng

City University of New York (CUNY) - Baruch College ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States

Jing Li (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

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