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    Auditor Quality and Loan Syndicate Structure.
    research summary posted October 13, 2015 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control 
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    Title:
    Auditor Quality and Loan Syndicate Structure.
    Practical Implications:

    The results are particularly interesting, given that high-quality audits are of incremental value in the syndicate loan market, where lead banks have privileged access to borrower inside information. While Big 4 auditors may be of less value to well-informed lead banks, they are likely to be of more value to less-informed non-lead participant lenders because higher-quality audits reduce the information asymmetry between the two parties. The authors recommend further research on the role of audits in private debt contracting in general and in structuring syndicate loans in particular, given the scarcity of evidence on the issue.

    Citation:

    Kim, J. B., and B. Y. Song. 2011. Auditor Quality and Loan Syndicate Structure. Auditing: A Journal of Practice & Theory 30 (4): 71-99.

    Keywords:
    auditor quality, lead bank, participant bank, syndicated loan
    Purpose of the Study:

    Syndicated loans are a hybrid of private and public debt” and a mix of relationship lending and transaction lending. On the one hand, lead banks screen and negotiate loan terms with the borrowers relying on their exclusive lender-borrower relationships; on the other hand, lead banks sell or underwrite part of the loans to participant lenders, which is analogous to public debt financing (such as bonds). Accordingly, information asymmetry exists not only between the borrower and multiple lenders, but also between (more informed) lead banks and (less informed) non-lead participant banks. Potential participant banks in the market are unlikely to be attracted to a loan syndicate in which their information disadvantage is significant and the probability of being exploited by the lead bank(s) is high. Moreover, expecting information asymmetry and the associated adverse selection and moral hazard problems, participant banks are likely to require the lead bank(s) to retain a large percentage of the syndicated loans.

    This study investigates whether and how the quality of a borrowing firm’s external auditor impacts the structure of its syndicate loans. Specifically, the authors address the following questions: (1) Do a larger number of lenders participate in a loan syndicate when the borrowing firm appoints a Big 4 (or previously Big 5 or Big 6) auditor than when it appoints a non-Big 4 auditor? (2) Do the lead banks of a loan syndicate retain a smaller proportion of syndicated loans when the borrowing firm appoints a Big 4 auditor than when it appoints a non-Big 4 auditor?

    Design/Method/ Approach:

    The initial sample consists of all publicly traded, nonfinancial firms that have syndicated loan data in the LPC DealScan database for the 14-year period 19962009. The authors extract the data on borrowers’ incumbent auditors and financial information from Compustat. The authors obtain a sample of 4,681 syndicated loan deals borrowed by 2,174 firms over the period 19962009.

    Findings:

    First, the authors find that borrowing firms with Big 4 auditors attract a larger number of lenders than those with non-Big 4 auditors. Second, lead banks retain a smaller proportion of syndicated loans when the loans are granted to firms with Big 4 auditors than when they are granted to firms with non-Big 4 auditors. The above findings are in line with the view that high-quality auditors are better able than low-quality auditors to monitor the financial reporting process and mitigate the information asymmetry problems in debt contracting. Finally, the authors also find that the impact of auditor quality on syndicate structure is less pronounced when banks are able to obtain more information about the borrower prior to the loan syndication. It suggests that the signaling value of hiring a Big 4 auditor is lower if lenders have prior knowledge about the borrower. The findings suggest that the quality of the borrower’s external auditor has a significant effect on the structure of a loan syndicate over and beyond other factors known to affect the structure of syndicate loans such as financial statement quality and firm transparency.

    Category:
    Audit Quality & Quality Control