Does the quality of lender–borrower relationships affect small business access to debt? Evidence from Canada and implications in China ☆ Sofia A. Johan a , Zhenyu Wu b, ⁎ a Entrepreneurship and Finance, Schulich School of Business, York University, Toronto, ON, Canada b Asper School of Business, University of Manitoba, Winnipeg, Manitoba, Canada abstract article info Available online xxxx JEL classification: G20 G30 G32 Keywords: Debt financing Relationship Small business The literature on corporate governance and entrepreneurial finance suggests that when lender–borrower rela- tionships are of longer duration, they tend to be more successful in solving the informational asymmetry prob- lems related to small business debt financing. Using the data from Canadian financial markets, this study first confirms this finding, insofar as the quality of lender–borrower relations is affected by traditional solutions to agency conflicts, lender requirements, and negative changes in the borrowing terms offered by lenders. However, in testing this conclusion further, we empirically demonstrate that, counter-intuitively, the quality of the lender– borrower relationship does not affect a small firm's access to debt, or change the terms of borrowing. We also show similar supporting evidence from lenders to small firms in China, where business relationships involving “guanxi” (or connections that are beneficial for both parties) are commonly expected to influence access to debt. The robustness of the study's results is shown by the data from numerous lending institutions in a province of China. © 2014 Elsevier Inc. All rights reserved. 1. Introduction The literature on debt financing tends to follow two complementary directions. One direction of investigation addresses a trade-off between the benefits of leverage and of bankruptcy risk, which is usually mea- sured by cash flow volatilities. The other direction focuses on the agency problems caused by the asymmetry of information between borrowers and lenders. Finance scholars have extensively studied the lender– borrower agency conflict for large, publicly listed companies, as abun- dant data from such firms is available (Bhattacharya & Thakor, 1994; Harris & Raviv, 1991; Petersen & Rajan, 1994). We believe, however, that further exploration is needed in the field of small business debt financing if we are to gain a clearer, more comprehensive picture (Bartholdy & Mateus, 2011). As heightened informational asymmetry problems are more common for smaller, private firms than for larger, public firms, many scholars have suggested that such problems can be overcome through forming long-term lender–borrower relationships. These scholars have proposed that quality relations with lenders can be an important and useful tool in helping small firms to successfully access debt financ- ing (Petersen & Rajan, 1994). More traditional solutions to lender– borrower agency problems have included bonding, screening, monitor- ing and signaling (Berger & Udell, 1995, 1998; Diamond, 1984; Petersen & Rajan, 1994, 1995). However, a pioneering study by Allen and Gale (1999) discussed the importance of long-term relationships between financial intermediaries and their customers. In a seminal work on en- trepreneurial finance, Shane and Cable (2002) addressed how entrepre- neurs use social ties to overcome financing difficulties. Another study by Arena (2011) looked at the credit quality of firms as a determinant of the types of debt financing sought. Both Petersen and Rajan (1995) and Boot and Thakor (2000) discussed the viability of relationship- based lending in the face of increased competition. In response to these investigations, we believe that our study fills an existing gap and adds to the growing literature on the effects of lender–borrower rela- tionships on small business debt financing. Using data from Canadian financial markets, we seek to explore whether the quality of lender–borrower relationships is a determinant of debt access for small firms, and whether relationship quality affects lenders' decisions concerning changes to the terms of financing or lend- ing. As the quality of lender–borrower relationships is influenced by tra- ditional agency tools for solving informational asymmetry problems, lenders' requirements, and negative changes in borrowing terms, we take these factors into consideration (Sharpe, 1990). Our empirical results show that after controlling for these interactions, the quality of International Review of Financial Analysis xxx (2014) xxx–xxx ☆ The research was partially sponsored by the Social Sciences and Humanities Research Council (SSHRC) under Canada Research Chairs Grant No. 950-226325, the Canada Foundation of Innovation (CFI) under Leaders Opportunity Fund No. 226325, and Manitoba Research and Innovation Fund (MRIF) No. 226325 for Wu. ⁎ Corresponding author at: 181 Freedman Crescent, Winnipeg, Manitoba, Canada R3T 5V4. Tel.: +1 204 474 8425. E-mail addresses: sjohan@schulich.yorku.ca (S.A. Johan), Zhenyu_wu@umanitoba.ca (Z. Wu). FINANA-00671; No of Pages 6 http://dx.doi.org/10.1016/j.irfa.2014.01.006 1057-5219/© 2014 Elsevier Inc. All rights reserved. Contents lists available at ScienceDirect International Review of Financial Analysis Please cite this article as: Johan, S.A., & Wu, Z., Does the quality of lender–borrower relationships affect small business access to debt? Evidence from Canada and implications in China, International Review of Financial Analysis (2014), http://dx.doi.org/10.1016/j.irfa.2014.01.006