The Effect of Bank Competition on Accounting Conservatism: Evidence from a Natural Experiment

This study exploits the Interstate Banking and Branching Efficiency Act (IBBEA) as a natural experiment to investigate the impact of bank competition on firms’ accounting conservatism. Since the IBBEA allowed banks to expand across state lines and unambiguously increased bank competition, I predict that after the staggered state-level adoption of the IBBEA, firms possess greater bargaining power in debt contracting and have fewer incentives to report conservatively. Using a DID research design, I find that firms’ financial reporting becomes less conservative after the IBBEA, and the effect is more pronounced for firms headquartered in states with higher bank competition, for firms with lower analyst coverage, smaller size and higher likelihood of bankruptcy, implying that firms with less external monitoring and higher risks are more likely to take advantage of the IBBEA to report less conservatively. My results are robust to using different time window sizes, and alternative measures of conservatism and return. In addition, I find that firms are given lower initial interest rates of bank loans initiated after the IBBEA, confirming that the IBBEA takes effect through the channel of debt contracting. Overall, my study suggests that bank competition plays a significant role in shaping corporate accounting conservatism.