Small business banking and financing:
a global perspective, Cagliari
The impact of an IFRS-adoption on relationship
lending for German SMEs – An economic
perspective
Philipp Grein
University of Bern
The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
Agenda
1.
2.
3.
4.
5.
Introduction
Characteristics of a lending relationship
IFRS versus German Commercial Code
Prior research on IFRS-adoption
The model
1.
2.
3.
4.
General assumptions
Information structure
Sequence of events
Equilibria for discrete strategies
6. Conclusion
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
1. Introduction
>
German SMEs primarily financed by relationship lenders due
to their size and informational opaqueness.
>
Long-term lending relationships help to overcome financing
constraints but relationship lender gains monopolistic position
>
Possible solution: Increased disclosure by adopting IFRS
>
Question:
•
•
•
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Can a SME really reduce its dependence from relationship
lenders by adopting IFRS?
Does an IFRS-adoption reduce the cost of debt for a SME?
Is an IFRS-adoption always beneficial for an SME with regard to
the financing situation?
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
2. Characteristics of a lending relationship
>
Lending relationships are of long-term nature:
•
>
Relationship lender:
•
•
•
>
Relationship lender accumulates information over time
has access to private information, which is of soft nature
provides largest share of debt capital of a debtor
assists debtor during times of financial distress
Access to private information decisive factor for the existence
of a lending relationship:
•
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Competition on loan market is reduced
 Problem of time inconsistency solved
 inter-temporal contracts possible
 Relationship lender is able to earn an information rent
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
3. IFRS versus German Commercial Code
>
German Commercial Code:
•
•
•
Influenced by tax accounting rules
Prudence principle very dominant
• assets cannot be valued higher than at their historical costs
• internally generated intangibles assets cannot be recognized
 creation of hidden reserves
Relief for smaller and medium firms with regard to the notes
(§326, § 327 HGB)
 Main accounting purpose:
• Determination of distributable income and capital maintenance
• Provision of information only of subordinate importance
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
3. IFRS versus German Commercial Code
>
International Financial Reporting Standards (IFRS)
•
•
•
Not influenced by tax accounting rules
Prudence principle less dominant:
• valuation at fair value of certain assets possible
• broader definition of assets
• internally generated intangibles assets can be recognized
 less creation of hidden reserves
• greater number of mandatory notes
No relief for smaller and medium firms
 Main accounting purpose:
• Provision of decision useful information (true and fair view)
>
IFRS-adoption increases amount and quality of disclosed
information
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
4. Prior research on IFRS-adoption
>
Disclosure and cost of capital across different accounting
standards
•
•
>
Accounting quality and cost of capital
•
>
Till now: evidence only for cost of equity capital
Ambiguous results (e.g. Leuz/Verrecchia and Daske)
Negative relationship for cost of equity capital as well as for debt
capital (e.g. Francis et al, Bharat/Sunder/Sunder)
Accounting quality of different accounting standards
•
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IFRS exhibit a higher quality than German GAAP
(e.g. Gassen/Sellhorn and Daske/Gebhardt)
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
5. The model
5.1
>
>
General assumptions
Model with two time periods
3 Players:
•
•
•
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Owners of an owner managed firm either of type G or of type B
Relationship lender
Outsiders
Investment program:
•
•
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Owner can run two consecutive investment projects, initial investment
of I each:
• Project 1: starts in t=0, pay-off 0 or X in t=1
• Project 2: starts in t=1, pay-off 0 or Y in t=2
Probability of success: π with πB < πG
Both projects only for type G positive net present value
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
5. The model
5.1
>
General assumptions
Financing:
•
•
•
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Only debt financing possible
Outsider and relationship lender simultaneously offer an interest
rate
Relationship lender incur relationship building costs cHB if
chosen as financier
Financing of both types in t=0 and t=1 is associated with a loss
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
5. The model
5.2
Information structure
>
Sequence of events, pay off structure of investment projects, and ex
ante probabilities are common knowledge
>
In t=0 only entrepreneur observes his true type
>
If relationship lender is financier of first investment project, it can
observe true type of entrepreneur after completion of first project
>
Outsiders rely only on publicly observable information
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
5. The model
5.2
Information structure
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In t=1 entrepreneur chooses either information systems HGB or IFRS
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If IFRS is chosen and entrepreneur is type G:
IFRSG  ΦG
IFRSS  1-ΦG
>
If IFRS is chosen and entrepreneur is type B:
IFRSS  ΦS
IFRSG  1-ΦS
 IFRS as verifiable signal on type of entrepreneur
>
Assumptions:
1. IFRS is informative: ΦG>0,5 and ΦS>0,5
2. German GAAP no information content, no signal sent
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
5. The model
5.3
Sequence of Events
0
1
Owner
Relationship Return from
lender or
project one: chooses an
information
other lenders
0 or X
system, IFRS
provide I
or HGB
Loan is
Entrepreneur repaid if
starts project possible
one
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2
Relationship
lender observe
owner’s type
If owner chooses
IFRS, outsiders
observe signal on
owner’s type
Relationship
lender or
outsiders
provide I
Owner
starts
second
project
Return from
project two:
0 or Y
Loan is
repaid if
possible
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
5. The model
5.4
>
Equilibria for discrete strategies
Assumption:
•
•
>
Relationship lender offers either rmax or rd
Outsiders offer either rd or make no offer
Without information system:
•
•
•
Outsiders never make an offer
Relationship lender earns information rent by financing second
project with rmax
Information rent exceeds losses from first project
 Relationship lender is willing to finance project in t=0
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
5. The model
5.4
>
>
Equilibria for discrete strategies
With information system two types of equilibria in t=1, separating or
pooling
Pooling equlibria:
1. Both types choose German GAAP
 same equilibrium as in situation without information system
 outsiders have sceptical expectations
2. Both types choose IFRS (assumption: no cost of adoption)
• Very high information quality: relationship lender offers rd, outsiders
offer rd if signal indicates good type
• High information quality:
equilibrium in mixed strategies
• Medium information quality: relationship lender offers rmax, outsiders
offer rd if signal indicates good type
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
5. The model
5.4
>
Equilibria for discrete strategies
Separating equilibrium (cost of adoption equals b)
•
Type G entrepreneurs adopt IFRS, Type B entrepreneurs keep
German GAAP
• Type G entrepreneurs receives financing in t=1 at rmax
• Type B entrepreneurs receive no financing in t=1
 Equilibrium holds only if cost of adoption is sufficiently high but
not too high
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
5. The model
5.4
Equilibria for discrete strategies
>
Equilibrium of entire game depends on outcome of second
stage
>
If information rent is significantly reduced, relationship lender
is not going to invest in a relationship
 depends on information quality of IFRS, on adoption
costs and on relationship building costs
 Both entrepreneurs do not receive financing in t=1
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The impact of an IFRS-adoption on relationship lending for German SMEs – An economic perspective
6. Conclusion
>
Effects of an IFRS-adoption for the financing of SMEs depends on
information quality of IFRS
>
If IFRS of sufficient information quality:
 Mitigation of hold up problem possible
 Cost of debt financing reduced
>
But: Relationship lenders looses ability to earn information rent
•
•
Nature of existing lending relationships alter:
 willingness to provide assistance during financial distress declines
Banks may no longer be willing to establish lending relationships
 Credit availability for very young SMEs declines
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