Summary:
The literature disagrees on the role of risk disclosures in annual reports. There are three competing hypotheses about the role of risk disclosures. The neutrality hypothesis holds that risk disclosures in annual reports are of little significance to market participants. The convergence hypothesis suggests that risk disclosures provide homogeneous public information and reduce the cost of capital. The divergence hypothesis proposes that such risk disclosures provide heterogeneous information and increase the cost of capital. These contrasting hypotheses indicate that the perceived attributes of risk disclosures in annual reports differ, thus the economic implications for market participants may also be different. Most studies focus on the economic consequences of risk disclosure from the perspective of equity and bond investors rather than that of banks. However, banks may pay more attention to risk disclosures in annual reports, as they are useful for banks to comprehensively assess a firm's credit risk. Therefore, studying the impact of risk disclosures on bank loan interest rates can help in understanding the economic consequences of risk disclosure in annual reports from the bank's perspective. How banks interpret the risk disclosures in annual reports will be reflected in their loan interest rates. If the risk disclosure provides information with low heterogeneity, the information asymmetry should be lower. With transparent information, the bank can assess the credit risk more efficiently and effectively, decreasing the bank's risk perception level, such that the loan interest rate may also decrease. In contrast, if the risk disclosures provide heterogeneous information, it should be more difficult for banks to assess the credit risk. Accordingly, the level of perceived risk will increase, and loan interest rates will increase. Based on 4,339 “firm-year-loan” observations of interest rates from 2008–2017, this paper reports three main findings. (1) Consistent with the convergence hypothesis, annual report risk disclosure by Chinese firms reduces the bank loan interest rate. This finding still holds after we exclude the effects of disclosure momentum, industry disclosure level, bank-enterprise connections, and other endogenous problems. (2) Information quality and risk are incomplete mediators when risk disclosures affect bank loan interest rates; that is, annual report risk disclosures lower the bank loan interest rates through improving information transparency and reducing the bank's risk perception level. (3) The negative correlation between risk disclosures and bank loan interest rates is mainly concentrated in the tight monetary policy group, the non-state-owned enterprises group, and the better corporate governance group. This suggests that banks pay more attention to the risk disclosures of non-state-owned enterprises and firms with better corporate governance during periods of tight monetary policy.There are no studies in the literature on the determinants of loan interest rates from the perspective of risk disclosures in annual reports or on the economic consequences of risk disclosures from the perspective of loan interest rates, which may better reflect the substance of risk disclosures due to the strong ability of banks to interpret this information. This paper is the first to study the relationship between loan interest rates and annual report risk disclosures, thus enriching the literature on risk disclosures and bank loans. The findings show that risk disclosures in annual reports reduce loan interest rates by improving information transparency and reducing the bank's perception of risk. Our findings thus support the convergence hypothesis. This paper shows that in annual report risk disclosures Chinese firms do not provide information with high heterogeneity, which is inconsistent with the intention of the regulatory agency that mandatesthe disclosure of risk information. Therefore, the regulatory agency may need to adjust the regulations or strengthen the penalties to induce companies to disclose more risk information. In addition, the loan interest rate includes more information than the loan amount, but as disclosing loan-level interest rates is not common, regulatory authorities should further require this disclosure. Future research could examine the specific impact of risk disclosures on different types of loans.
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