The impact of accounting environment, firm and loan attributes on non-performing loan ratios of countries: the moderating role of good governance

This study aims to investigate how accounting environment, mean firm attributes, and loan collateralization culture, and good governance of a country affects overall non-performing loan ratio (NPL). The study relies on the notions of a stream of theories based on institutional theory to predict that institutionalized political-economic structures, along with features of borrowing-lending field, may affect NPL significantly. Guided by the theoretical stream, we also aim to test whether broader political-economic structure, i.e., good governance in our case, moderate impact of field specific variables (e.g. accounting environment, average firm and loan attributes) on NPL. Utilizing data on 73 countries for the years 2010–2018 published by the World Bank and applying two-step system GMM models, we find that overall good governance, accounting environment, mean firm attributes, and loan collateralization affects NPL significantly. Of the elements of accounting environment, better disclosure is found to unearth more NPL while external audit pervasiveness reduces NPL, albeit insignificantly. Countries with significant state ownership and more women representation in firms have significantly lower NPL ratios while NPL is significantly higher in countries with higher average firm sales growth. Average firm age in a country does not affect NPL significantly. In line with the ex-post theory of collateral, we found significant positive association between loan collateralization culture and NPL. Our findings support the theoretical predictions that institutionalized political-economic structure significantly affects NPL and moderates the impacts of other field-specific variables on NPL. Good governance is found to significantly reduce NPL and moderate impact of most of the other field-specific variables on NPL. In fact, good governance is economically the most significant in reducing NPL. Accounting environment works more effectively in preventing NPL when good governance is ensured. Both disclosure and external audit significantly reduces NPL in the presence of good governance. External audit becoming significant in reducing NPL when good governance is ensured may indicate that audit quality improves if good governance exists. In presence of good governance, NPL is significantly lower in countries with more matured firms and those with more female representation in firms. NPL is significantly higher in the presence of good governance if there are more firms with significant state ownership. Good governance cannot significantly moderate the association between loan collateralization culture and NPL. Additional analyses reveal that the impacts of the variables differ significantly between high-NPL and low-NPL countries. The associations also differ notably between European and non-European countries where European economies in our sample are developed/transition economies while non-European countries are all developing economies. State ownership, and sales growth reduced NPL in European countries in the sample during the European crisis whereas good governance, loan collateralization, and external audit lost significance during the crisis years. Robustness of our findings has also been checked and confirmed. Our findings have remarkable policymaking, managerial, and social implications including significant implication for the current global initiatives for harmonizing accounting and auditing practices as well. Global accounting bodies should consider that accounting and auditing practices become more effective when the broader institutionalized accountability framework is strong. Global economic policymakers should emphasize on ensuring good governance in countries lacking it to ensure global financial stability. Managers of multinational financial institutes should take into consideration the institutional environment of the counties of operation while setting lending interest rates in different countries as strong institutional framework sets foundation for effectiveness of many field-specific factors in reducing NPL. Economic policymakers of countries with unstable banking sectors may consider extending state ownership in firms. Banking policymakers of different economies should consider that wider loan collateralization may trigger relaxed borrower scrutiny, or reluctance to repay and increase NPL. Also, the finding that maturity of borrowing firms does not reduce NPL significantly may affect decisions of bank managements to lend to mature firms at lower interest rates. Our findings that empowering women by increasing female representation in the top positions of firms of a country can reduce NPL substantially advocates significant social reform, particularly in countries where women lag behind males in corporate arena.