Managing Expectations Through Budgetary Slack: Evidence from Project Financing

In this study, we examine whether mandatory management forecast characteristics are influenced by lender expectations around project financing approvals. In our setting, debt enters the firm's capital structure for the first time and thus firms experience the initiation of bank monitoring. We contend that managers will be motivated to meet the expectations of lenders, who are primarily concerned with cost overruns and project failure, through the creation of budgetary slack. In particular, we examine whether project financing approvals impact mandatory cash flow forecast accuracy and bias. Using a large sample of firms that provide mandatory forecasts of expected future cash outflows around project financing approvals, we find that managers' forecasts become less accurate and more biased. In particular, consistent with the creation of budgetary slack, cost overestimates increase after project financing approval, yet we observe no difference for underestimates. Examining the timing of the overestimation, we find that managers are more likely to create budgetary slack while debt tranches remain to be drawn, coinciding with high-risk construction during the development phase. We interpret these results as evidence consistent with the use of budgetary slack to manage lender expectations and mitigate concerns of cost overruns. The results of our study build upon extant work which examines the relation between corporate disclosure and external monitors. In so doing, our study sheds light on 'transactional' or one-time lending arrangements rather than the more 'relational' or repeated-game lending arrangements found in syndicated loans. Overall, the results of our study speak to how managers alter mandatory forecast characteristics when their projects become subject to lender monitoring.