The effect of SME reporting framework and credit risk on lenders' judgments and decisions

Abstract Small and medium-sized entities have a number of reporting framework alternatives when preparing financial statements for users, including a new AICPA reporting framework designed specifically for such businesses as a cost-effective alternative to traditional GAAP. However, little is known about whether reporting framework choice affects users’ assessments of reporting quality and subsequent business decisions. This study evaluates the effects of financial reporting framework type and credit risk on lenders’ judgments and decisions. Specifically, we evaluate 157 lenders’ assessments of the likelihood of loan approval and financial reporting quality for a prospective borrower in an experiment that manipulates reporting framework choice (FASB-based GAAP, AICPA’s Financial Reporting Framework for Small and Medium-Sized Entities, or tax-basis) and borrower credit risk level (high or low) randomly between subjects. The results indicate a significant interaction between applicant reporting framework and credit risk level. Specifically, we find that lenders evaluating GAAP-based financial statements report a higher likelihood of loan approval and a lower interest rate than lenders considering statements prepared using the other reporting frameworks, particularly when the applicant’s credit risk level is high. Mediation analysis provides evidence that the perceived quality of GAAP-based reporting explains the framework-approval results. However, the results also suggest that the AICPA reporting framework provides a viable alternative to GAAP when the applicant’s credit risk level is low. We consider the study’s implications for policy, practice, and research.