The Interpretation of Industry Characteristics for the Relationship between Financial Reporting Quality and Terms of Debt Contracting

Abstract

There are three opinions about the relationship between FRQ and TOD. Firstly, when the amount of debt increased the FRQ should be increased because banks required audited financial statements in order to give the borrowers more favorable terms (Kardan, Salehi, & Abdollahi, 2016). Secondly, borrowers used to camouflage and manipulate the financial information in order to show a stable financial position and consequently raise their level of debt (Dichev & Skinner, 2002). Thirdly, it’s a combination of the two previous opinions (Ghosh & Moon, 2010). Thus, the research agrees with the third opinion because banks required a higher level of FRQ in order to give the borrowers more favorable terms. At the same time, borrowers need to raise their level of debt by presenting a higher level of FRQ by using the actual numbers or compensating it with earning management techniques. In less developed markets the creditors' protection and legal enforcement are weak and they have a higher level of information asymmetry (IA) between creditors and borrowers (Gomariz, & Ballesta, 2014). So, creditors protect themselves by relying on the financial statements (FS) and used it as an indicator of the company performance and taking their decisions according to the level of FRQ (Ding, 2016). A higher level of FRQ will lead to a decrease in the level of IA and gives the creditors a better assessment of the borrowers (Ding, 2016). Moreover, the crises and financial distress