MD&A readability and bank loan contracting: evidence from China

ABSTRACT

We investigate whether and how the textual characteristics of management discussion and analysis (MD&A) can affect bank loan contracting using a sample of 31,141 loan-firm-year observations in China. We document a strong negative relationship between a firm’s MD&A readability and its cost of borrowing, in line with the argument that banks incorporate borrowers’ information risk into pricing. Cross-sectional analyses suggest that the relation between MD&A readability and loan contract terms is less pronounced when borrowing firms are state-owned or have political connections, when firms are located in areas with more developed credit markets, and when lending banks are large shareholders.

KEYWORDS:

• MD&A
• readability
• bank loan
• China

Acknowledgments

We gratefully acknowledge the financial support from Major Program of National Fund of Philosophy and Social Science of China (23&ZD072), the General Program of National Natural Science Foundation of China (72272125), China Postdoctoral Science Foundation (2023M741164) and the National Philosophy and Social Science Fund of China(21CGL054).

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. The legitimacy theory states that corporations attempt to win and sustain their legitimacy through contracting with society by taking actions that are beneficial to the community and meet society’s expectations (Deegan 2002; Suchman 1995).

2. Our measure based on human judgments has certain advantages over computer-aided algorithm measures. First, there are no generally accepted algorithmic measures of readability in Chinese (Xu, Yao, and Chen 2019). Second, Chinese is more complicated than English, as it is difficult to assess the meaning of a sentence outside of its specific context. These reasons make human judgments extremely important and necessary in the Chinese setting.

3. The analysis in Table 4 is conducted at the firm-year level including all listed companies, not just those disclosing loan information. We re-examine Table 4 based on the subset of companies disclosing loan information only and find consistent results.

4. The CSRC specifies the requirements for disclosure of MD&As in ‘The Standards for the Contents and Formats of Information Disclosure by Companies Offering Securities to the Public No. 2—Contents and Formats of Annual Reports (2012 Revision)’ issued on September 19th, 2012, which outlines higher requirements for disclosure quality relative to reliability, relevance, and effectiveness. This document clearly states that discussion and analysis in MD&As should not simply duplicate the content of the financial reports but focus on the analysis of important business and financial indicators, the disclosure of substantive content, known important trends, and uncertainties.

5. The very first version of the NERI index was published by Fan and Wang (2001), and the most recent version is included in Fan, Wang, and Yu (2017). The NERI marketization index aims to capture the development of five aspects of the institutional environment in China: (1) government decentralization, (2) development of the non-state sector, (3) development of product markets, (4) production factor markets, and (5) market intermediaries and the legal environment. Credit market development is one of the subindices under production factor markets based on scores for competition in the financial industry and scores for the marketization of credit fund allocation.