The impact of joint venture accounting methods and the guarantee of joint venture debt on corporate lending decisions and debt convenant restrictions

Standard setters worldwide have called for ex ante research to investigate the impact of different joint venture accounting methods on user decision making. This study responds to that call by investigating whether and how the judgments and decisions of corporate lending officers are affected by the method of joint venture accounting (equity method, proportionate consolidation) and/or the guarantee of joint venture debt.;Corporate lending officers routinely rely on financial statement values and ratios to price loans and structure lending agreements. Economic theory predicts corporate lending officers will choose a higher rate of interest and establish lighter debt covenant restrictions in response to the substantive risk of joint venture debt guarantees but not to nominal differences in joint venture accounting methods. However, if financial statement ratios and values serve as anchors, cognitive theory predicts lending decisions will differ across the method of joint venture accounting and the guarantee of joint venture debt because cosmetic differences in joint venture accounting methods allow the venturer to appear less risky even when the underlying substantive risk is greater.;By experimentally manipulating the method of joint venture accounting (equity method, proportionate consolidation) and the guarantee of joint venture debt (guaranteed, non-guaranteed), this study presented corporate lending officers with financial statements from a fictitious borrower and asked them to assess the probability of repayment, set an appropriate interest rate, and establish five debt covenant restrictions (leverage, cash coverage, current ratio, interest coverage, net worth). Consistent with economic theory, corporate lending officers assessed a lower probability of repayment and a higher interest rate when the debt of the joint venture was guaranteed regardless of the method of joint venture accounting.;While corporate lending officers did not appear to establish tighter debt covenants in a manner consistent with either economic theory or cognitive theory, additional analysis indicates that corporate lending officers tailored debt covenants and/or established fixed GAAP provisions when the debt of the joint venture was guaranteed. Taken together, these results suggest that corporate lending officers respond to the substantive risk of joint venture debt guarantees but not to nominal differences in joint venture accounting methods.