Financial reporting quality and the cost of debt of SMEs

This study explores a large and detailed dataset of financial statements of Belgian small and medium-sized enterprises (SMEs) over the 1997-2010 period. Using accruals quality as a proxy for the quality of SMEs' financial reports, we find that the quality of SMEs' financial statements is negatively related to those companies' effective interest cost. This result is also highly economically significant. The findings in this paper are consistent with the idea that earnings are important for creditors in predicting SMEs' reimbursement capacity (i.e., future cash flows) and that less estimation error in accruals enhances earnings' ability to predict future cash flows. We deliver evidence of an important economic benefit of financial reporting for SMEs, to wit, the potential to reduce information asymmetry between SMEs and their creditors through higher-quality financial reporting.