Loan guarantee, management earnings forecasts and cost of debt: evidence from Chinese manufacturing firms

Abstract

AbstractOne of the most pressing issues facing developing economies is how to provide expansion capital for existing businesses. However, this issue is more pressing in China, where private enterprises suffer significant financial constraints from capital market limitations. Therefore, the significance of obtaining third-party loan guarantees rises among private firms in the secondary loan market. This study investigates the relationship between loan guarantees and the firm’s cost of debt and the moderating effect of management earnings forecasts. We find that loan guarantees have a significant negative relationship with the firm’s cost of debt. However, a positive relationship between information asymmetry measures and loan guarantees is more pronounced, suggesting that loan guarantees reduce the significance of information asymmetry issues, which impair borrowing firms’ re-payment ability and increase the credit risk of guarantors and banks. In contrast, frequent and quality management earnings forecasts help firms to build their reputation in the market by reducing the concerns of information asymmetry, information risk, agency problems, and loan repayment with banks, which, in turn, benefit firms in reducing their cost of debt. Our study results are robust to the use of two-stage least square analysis, and Heckman two-stage treatment effect model. This work offers the latest contribution to the recent understanding of the effects of loan guarantees in reducing the cost of debt and the vital role of management earnings forecasts in firms’ growth.

Keywords

• Management earnings forecast
• loan guarantee
• cost of debt
• information asymmetry
• Jasman Tuyon, Universiti Teknologi MARA, Kota Kinabalu, Malaysia
• Finance