LENDERS USE OF ACCOUNTING INFORMATION IN THE OIL AND GAS-INDUSTRY

A borrowing base is a line of credit set by the lender and secured by petroleum assets. Borrowers can draw on the borrowing. base only to th e extent that their investment opportunities justify the related inter est expenses. This measure of the firm's capacity to obtain secured lo ans is footnoted in the long-term debt section of the annual reports. In this paper we examine how lenders use accounting information to set the borrowing base of oil and gas firms. Determination of the borrowi ng base is a vital decision because it represents the lenders' exposur e in the event that the borrower defaults.1 We find evidence on lender s' use of accounting information by examining actual lending agreement s as well as through tests of association. Our sample consists of smal ler petroleum firms that have a higher probability of default ff unfav orable contingencies occur. The primary finding is that the value of f irm's oil and gas reserves explain a large proportion of the variation in the firms' borrowing base and total outstanding debt. Unlike prior studies, we find that reserve recognition accounting (RRA) has a high er explanatory power than book values. Although major fluctuations in oil prices during the period of the study, 1984-1987, suggest that his torical costs may be relatively poor indicators of changes in asset va lues, we observe that RRA information is used in setting the borrowing base for 21 of the 23 firms for which such agreements were available. The evidence reported in this article complements prior research (Har ris and Ohlson 1987, 1990, Ghicas and Pastena 1989)2 and enhances the regulators' implication that their mandated RRA information is useful to users of financial statements.