Shaping Firms’ Financial Reporting: Evidence From the Spillover Effect of the FED’s Stress Test

Abstract

This research investigates how bank regulation, specifically the stress test conducted by the Federal Reserve (FED), influences the financial reporting decisions of borrowers. Previous studies indicate that the FED’s stress test can lead to a reduction in credit supply and stricter lending standards for banks. Expanding on this body of literature, our study shows that the impact of the stress test reaches beyond lenders, prompting borrowers to embrace increased conditional conservatism in their financial reporting. This spillover effect is particularly pronounced for riskier borrowers. Our findings suggest a far-reaching impact of FED regulation on firms’ financial reporting choices. Further analysis indicates that borrowers transitioning from tested banks to untested banks experience higher interest rates following the stress test, highlighting an extended spillover effect on borrowers.