SOFT INFORMATION PRODUCTION IN SME LENDING

• Author: Mark D. Griffiths,Belinda L. Del Gaudio,Gabriele Sampagnaro
• Date: 01 March 2020
• Published date: 01 March 2020
• DOI: http://doi.org/10.1111/jfir.12198

The Journal of Financial Research Vol. XLIII, No. 1 Pages 121–151 Spring 2020

DOI: 10.1111/jfir.12198

SOFT INFORMATION PRODUCTION IN SME LENDING

Belinda L. Del Gaudio

University of Naples Parthenope

Mark D. Griffiths

University of Southern California

Gabriele Sampagnaro

University of Naples Parthenope

Abstract

We analyze the determinants of soft information production on bank clients

assuming that this information is collected through close contact with borrowers.

After classifying contacts based on the initiator and the location of the

lender–borrower meetings, we find that banks have more direct contact with firms

characterized by low risk and low use of their banking products, indicating that there

may also be commercial reasons for such contact. Our findings suggest that the

production of soft information may follow a quality selection process in which banks

prefer to strengthen relationships with clients characterized by low risk and low use

of their products. We provide additional evidence of the role of soft information in

ongoing interactions between banks and borrowers. Banks that initiate contacts at the

firm location result in future lower risk, lower spreads, and increased product sales.

JEL Classification: G20, G21, G32

I. Introduction

The literature has noted the importance of soft information in the lending decision,

especially in increasing the ability of banks to cope with opaque borrowers (see, e.g.,

Berger and Udell 1998; Berger, Klapper, and Udell 2001; Cole, Goldberg, and White

2004). In this article, we investigate empirically the production of soft information

through an analysis of the determinants of bank–firm contacts. In particular, as in the

earlier literature (see, e.g., Liberti and Petersen 2018; Agarwal and Hauswald 2010;

Berger and Black 2011), we assume that loan officers collect soft information primarily

through face‐to‐face contacts with borrowers. We then use the number of contacts as a

proxy for the amount of soft information produced. This approach helps shed new light

on relationship lending practices based on soft information, despite the well‐known

difficulty of measuring this type of information.

Soft information is information that is not verifiable by a third party and

includes hypothetical and/or intangible information, such as economic projections,

We thank the editors of the Journal of Financial Research and two anonymous referees for constructive

comments on a previous version of this paper.

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© 2019 The Southern Finance Association and the Southwestern Finance Association

assessments of a firm’s management quality, and employee morale. This type of

information is thought to be accessible exclusively to a primary lender and cannot be

unambiguously documented in a report that a loan officer could present to superiors.

Compared to the use of “hard”information, the use of such private information across a

bank’s organizational layers can be difficult and is primarily employed in relationship‐

based banking that accrues importance as it ascends the hierarchical ladder (Liberti and

Petersen 2018; Liberti and Mian 2009).

Research in relationship banking generally suggests that soft information can

improve contracting efficiency and affect a firm’s cost of and/or access to credit (see,

e.g., Boot and Thakor 1994; Petersen and Rajan 1994; Berger and Udell 1995;

Blackwell and Winters 1997; Elsas 2005; Peltoniemi 2007; Puri, Rocholl, and Steffen

2011; Bartoli et al. 2013; Gobbi and Sette 2014; Beck et al. 2018), collateral

requirements (Chakraborty and Hu 2006; Brick and Palia 2007; Behr, Entzian, and

Güttler 2011), and other important organizational features, such as the portability of

soft information across organizational layers, delegation of the loan approval process

(Liberti and Mian 2009; Degryse, Laeven, and Ongena 2009; Agarwal and Hauswald

2010; Nemoto, Ogura, and Watanabe 2013; Filomeni, Udell, and Zazzaro 2016),

corporate governance (Dass and Massa 2011), and firm innovativeness (Giannetti

2012). Furthermore, the role of soft information is explicitly considered in the literature

on banks that specialize in lending to small‐and medium‐sized enterprises (SMEs)

(Stein 2002; Berger and Udell 2006; Berger, Rosen, and Udell 2007; Delgado, Salas,

and Saurina 2007; Berger and Black 2011; De la Torre, Martínez Pería, and

Schmukler 2010).

Although past studies provide a comprehensive background on the role played

by soft information in lending practices, the manner in which a bank gathers this

information remains underexplored. To fill this gap, we exploit the fact that soft

information is typically available through personal contact and observation, and

investigate the production of this type of information by analyzing the number of

lender–borrower contacts within a given period. We further identify the frequency of

personal contact as a measure of soft information production that is both intuitive and

legitimized by the academic literature, differentiating several types of contacts. A

physical contact frequency measure is inadequate to explore the origin of soft

information because the production of this type of information can be a function of

other attributes, such as where meetings occur or who takes the initiative to arrange a

meeting. Thus, a more detailed classification of meetings based on these attributes

enables a more accurate exploration of bank–customer interaction and, indirectly, the

production of soft information.

For example, if we classify meetings based on location (i.e., at the bank’sor

the firm’s offices), a meeting at the firm’s headquarters may be more valuable to the

bank than a meeting at the bank’s offices. Indeed, this opportunity to observe various

firm features and characteristics—such as facilities, equipment, technical innovation,

the firm’s approach to customers, the manager’s ability, the manager’s honesty, the

workers’reliability, how workers react under pressure, and the workers’relationships

with the employer—allows the bank representative to inspect and appreciate (or not)

the firm.

122 The Journal of Financial Research