Debt misreporting and bank lending

Abstract

This paper documents debt misreporting in unaudited financial statements and examines its sources and implications for bank lending. Using a unique combination of datasets, we measure debt misreporting as the difference between firms’ bank debt reported on the balance sheet and the corresponding information recorded in the public credit registry. We find that debt misreporting is not randomly distributed and that firms with greater financing needs are more likely to underreport, rather than overreport, their debt. We further show that underreporting is more prevalent when firms approach new lenders, consistent with firms using it in an attempt to obtain credit. In terms of credit supply, these firms receive less credit, particularly from banks with greater prior exposure to misreporting and from banks that verify borrower information through the credit registry. In addition, underreporting firms exhibit subsequent signs of financial weakness, including delays in supplier payments and a higher probability of non-performing loans, charge-offs, and insolvency. Overall, our findings suggest that a substantial part of debt underreporting is strategic and that banks take it into account when making credit decisions.