Young and small private firms typically face severe financing problems due to serious information symmetries and agency problems (Bergerand Udell (1998)). Informational opacity is due to a limited track record in the financial market. Further, young and small firms typically have little tangible assets which maybe pledged to secure loans. In order to compensate for higher risk creditors may charge higher interest rates, however, besides legal limits there are economic limits to do so since higher interest rates may even aggravate adverse selection and debtor moral hazard (Stiglitzand Weiss (1981)). The basic question is: How can we overcome information and financing problems of young and small firms considering their most important role for gross national product, for innovation and for employee workforce?
Relationship lending is an important way to mitigate the financing problems of young and small firms (venture capital is an alternative one). A relationship lender which often isa commercial bank might be willing to lend money if the debtor firm commits to along-term relationship. The relationship lender is likely to lose money with young and small firms in the early years of the relationship. Those losses have to be compensated by gains from higher than-competitive rates when the debtor firm gets more mature and more profitable. The relationship bank is able to realize higher-than-competitive rates when she has an information advantage towards outside lenders. In the course of the lending relationship the bank collects information on the firm'sprospectsand quality which is mainly private and soft in nature (Boot (2000)).
Soft information is information which the debtor firm is unlikely to reliably transfer to outside lenders (cheap talk problem). Superior information allows the relationship lender to realize information rents without being afraid that the debtor firm switches. Notice that outside lenders do not have private information and face the general problem of adverse selction, thus asking for higher riskpremia. The information rent of the relationship lender compensates for the losses in the early years of the relationship.
There is strong evidence that relationship lending increases credit availability for young and small firms (Petersonand Rajan (1994), Bergerand Udell (1998)) and that relationship banks are more willing to help when the firm is in financial distress (Longhoferand Santos (2000), Brunnerand Krahnen (2008)). In order to make this long-term relationship working the relationship bank aims to keep as much superior information as possible.
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Relationship Lending and Conservative Accounting? Empirical Evidence from Private Firms
