The Effects of Internal Control Problems and Tolerance for Ambiguity on Lending Judgments

Abstract

Purpose: This research examines whether lenders’ judgments are more adversely impacted by disclosures of material weaknesses versus significant deficiencies in a borrower’s internal controls. This study also examines whether lenders’ tolerance for ambiguity affects lending judgments. Methodology: An experiment was conducted with lending officers, who provided risk assessments and lending probabilities for a hypothetical loan applicant company. One independent variable, the company’s internal controls, was manipulated using two levels – material weaknesses versus significant deficiencies. The other independent variable, tolerance for ambiguity, was measured with a commonly used scale for this attribute. Major Conclusions: The severity of internal control problems had no effect on either risk assessments or probabilities of granting a line of credit. In addition, tolerance for ambiguity did not affect risk assessments, but lenders with a high tolerance for ambiguity had an average credit granting probability that was lower than lenders with a low tolerance for ambiguity.