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

One 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.A firm’s loan guarantee is oftenrecognizedasauseful instrument for mitigating the risks involved with borrowing to firms that lack a solid credit history and auditing procedures. However, loan guarantees are frequently associated with riskier or lower-quality borrowing enterprises, which leads to serious information asymmetry problems. This, in turn, has a negative effect on the company’s reputation and exposes it to threats of bank and guarantor non-payment. Our empirical study looks at how loan guarantees might reduce debt costs by neglecting information asymmetry in the bank lending process. Furthermore, our findings provide empirical evidence of the substitution effect of management earnings forecasts over loan guarantees in lowering the firm’s cost of debt. The findings imply that both loan guarantee and management earnings forecasts have a negative impact on firms’ cost of debt in China. First, on the one hand, the loan guarantee lowers the cost of debt by ignoring information asymmetry, which results in adverse selection and ethical uncertainty concerns, both of which raise the default and litigation risks faced by financial institutions and clients. Second, management earnings forecasts have a substitution effect on funding injection into China’s bank loans. It may help firms improve their reputations, reducing informational asymmetries concerns such asunfavorableshortlisting and ethical inconsistency, and lowering their cost of debt in banks’ credit lendingprograms. The present study contributes to the most contemporary understanding of the impacts of loan guarantees on debt cost reductions and the critical role of management earnings forecasts in company expansion.