One of the most significant capital market developments over the last two decades has been the growth of private capital markets—markets that raise capital outside of publicly traded venues and can face substantially less mandated public financial reporting. Understanding the causes and consequences of the relative growth of private capital markets is a first order research question. As private capital markets have grown, interest in regulating and researching private markets has increased. Research that is informative about the costs and benefits of regulating private capital markets should be in high demand. Kim and Olbert (2022, KO hereafter) dive into this arena to ask whether additional private firm disclosure affects public capital markets. KO find that as private firms disclose more financial statement information, the public equity holdings of mutual funds and ETFs decline. KO infer from their findings that increased private company disclosure results in negative pecuniary externalities for public companies. In this paper, I discuss KO's intriguing findings and suggest areas where research can build off and sharpen the inferences of this paper. In particular, future work can validate KO's measure of private company disclosure and consider the causal mechanism for investment in private firms.

ABSTRACT I examine how verification of financial statements influences debt pricing. I use a large proprietary database of privately held U.S. firms, an important business sector in which the information environment is opaque and financial statement audits are not mandated. I find that audited firms have a significantly lower cost of debt and that lenders place more weight on audited financial information in setting the interest rate. Further, I provide evidence of a mechanism for this increased financial statement usefulness: accruals from audited financial statements are better predictors of future cash flows. Collectively, I provide novel evidence that audited financial statements are more informative and that this significantly influences lenders’ decisions.

Using a data set that records banks’ ongoing requests of information from small commercial borrowers, we examine when banks use financial statements to monitor borrowers after loan origination. We find that banks request financial statements for half the loans and this variation is related to borrower credit risk, relationship length, collateral, and the provision of business tax returns, but in complex ways. The relation between borrower risk and financial statement requests has an inverted U-shape; and tax returns can be both substitutes and complements to financial statements, conditional on borrower characteristics and the degree of bank–borrower information asymmetry. Frequent financial reporting is used to monitor collateral, but only for non–real estate loans and only when the collateral is easily accessible to lenders. Collectively, our results provide novel evidence of a fundamental information demand for financial reporting in monitoring small commercial borrowers and a specific channel through which banks fulfill their role as delegated monitors.

Lending concentration features prominently in models of information acquisition by banks, but empirical evidence on its role is limited. Using bank-level loan exposures, we find banks are less likely to collect audited financial statements from firms in industries and regions in which they have more exposure. These findings are stronger in settings in which adverse selection is acute and muted when the bank lacks experience with an exposure. Our results offer novel evidence on how bank characteristics are related to the type of financial information they use and support theoretical predictions suggesting portfolio concentration reveals a bank's relative expertise.

ABSTRACT This study uses a comprehensive panel of tax returns to examine the financial reporting choices of medium‐to‐large private U.S. firms, a setting that controls over $9 trillion in capital, vastly outnumbers public U.S. firms across all industries, yet has no financial reporting mandates. We find that nearly two‐thirds of these firms do not produce audited GAAP financial statements. Guided by an agency theory framework, we find that size, ownership dispersion, external debt, and trade credit are positively associated with the choice to produce audited GAAP financial statements, while asset tangibility, age, and internal debt are generally negatively related to this choice. Our findings reveal that (1) equity capital and trade credit exhibit significant explanatory power, suggesting that the primary focus in the literature on debt is too narrow; (2) firm youth, growth, and R&D are positively associated with audited GAAP reporting, reflecting important monitoring roles of financial reporting; and (3) many firms violate standard explanations for financial reporting choices and substantial unexplained heterogeneity in financial reporting remains. We conclude by identifying opportunities for future research.

We examine whether discrimination affects customers’ willingness to pay their suppliers. Using a dataset of detailed trade credit networks, we find that when facing a macroeconomic shock, customers delay payments to their suppliers with female or black trade credit officers at a 10%–20% higher rate relative to their payments to non-minorities. These results hold after controlling for a host of economic differences between minority groups and non-minority groups. In particular, we exploit the complexity of the supply chain network – wherein suppliers transact with multiple customers in each month and customers transact with multiple suppliers in each month – to estimate within-relationship changes in payment behavior during periods of financial hardship. Results indicate that the largest increases in payment delays are between customers that are classified as having racial or gender biases and suppliers that have minority lead credit officers. The results suggest that biased beliefs and preferences play a critical role in trade credit.

ABSTRACT We use a proprietary data set of financial statements collected by banks to examine whether economic growth is related to the use of financial statement verification in debt financing. Exploiting the distinct economic growth and contraction patterns of the construction industry over the years 2002–2011, our estimates reveal that banks reduced their collection of unqualified audited financial statements from construction firms at nearly twice the rate of firms in other industries during the housing boom period before 2008. This reduction was most severe in the regions that experienced the most significant construction growth. These trends reversed during the subsequent housing crisis in 2008–2011 when construction activity contracted. Moreover, using bank‐ and firm‐level data, we find a strong negative (positive) relation between audited financial statements during the growth period, and subsequent loan losses (construction firm survival) during the contraction period. Collectively, our results reveal that macroeconomic fluctuations produce temporal shifts in the overall level of financial statement verification and temporal shifts in verification are related to bank loan portfolio quality and borrower performance.

ABSTRACT In this paper we develop a measure of competition based on management's disclosures in their 10‐K filing and find that firms’ rates of diminishing marginal returns on new and existing investment vary significantly with our measure. We show that these firm‐level disclosures are related to existing industry‐level measures of disclosure (e.g., Herfindahl index), but capture something distinctly new. In particular, we show that the measure has both across‐industry variation and within‐industry variation, and each is related to the firm's future rates of diminishing marginal returns. As such, our measure is a useful complement to existing measures of competition. We present a battery of specification tests designed to explore the boundaries of our measure and how it varies with the definition of industry and the presence of other measures of competition.

Using a dataset covering 3 million commercial borrower financial statements, we document a substantial, nearly monotonic decline in banks’ use of attested financial statements (AFS) in lending over the past two decades. Two market forces help explain this trend. First, technological advances provide lenders with access to a growing array of borrower information sources that can substitute for AFS. Second, banks are increasingly competing with nonbank lenders that rely less on AFS in screening and monitoring. Our results illustrate how technology adoption and changes in credit market structure can render AFS less efficient than alternative information sources for screening and monitoring.

We study the role of reputation in auditor-client matching. Using 1.2 million employment records from US broker-dealers, we find that broker-dealer clients of the same auditor have similar financial adviser misconduct profiles. Our estimates indicate that variation in client misconduct behavior is nearly half as important as variation in client size in explaining matches. Auditors adjust their portfolios when presented with new information about client behavior, and those with the most significant reputation concerns are least likely to deal with high misconduct clients. Finally, we find that an auditor's reputation for accepting high misconduct clients predicts their new clients' future misconduct. Together, our results present new evidence on how reputation affects audit relationships, and the consequences of auditors' reputation concerns for client behavior. Our results also indicate an unintended consequence of audit mandates: non-discerning auditors emerge to serve clients with low endogenous demand for auditing.