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Internal Control and Strategic Communication within Firms – Evidence from Bank Lending

Martin Brown (), Matthias Schaller (), Simone Westerfeld () and Markus Heusler ()

No 1504, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: The allocation of authority affects the communication of information about clients within banks. We document that in small business lending internal control leads loan officers to propose inflated credit ratings for their clients. Inflated ratings are, however, anticipated and partly reversed by the credit officers responsible for approving credit assessments. More experienced loan officers inflate those parameters of a credit rating which are least likely to be corrected by credit officers. Our analysis covers 10,568 internal ratings for 3,661 small business clients at six retail banks. We provide empirical support to theories suggesting that internal control can induce strategic communication within organizations when senders and receivers of information have diverging interests. Our findings also point to the limits of the four-eyes principle as a risk-management tool in financial institutions.

Keywords: Internal Control; Authority; Information; Small Business Lending (search for similar items in EconPapers)
JEL-codes: D23 G21 G34 L20 M2 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2015-02, Revised 2015-07
New Economics Papers: this item is included in nep-ban and nep-rmg
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