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    Auditor Changes and the Cost of Bank Debt
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes 
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    Title:
    Auditor Changes and the Cost of Bank Debt
    Practical Implications:

    Currently, bank loans account for more than half of the total debt financing in the United States. The results from this study indicate that there is an increase in loan costs for companies within the following year of an auditor change. This is a factor companies should consider when applying for loans after a switch. 

    Citation:

    Francis, Bill B., D. M. Hunter, D. M. Robinson, Michael N. Robinson, and X. Yuan. 2017. “Auditor Changes and the Cost of Bank Debt”. The Accounting Review. 92.3 (2017): 155.

    Keywords:
    auditor change; information risk; financial reporting quality; information signaling; loan contracting; cost of bank debt; loan spreads; private credit market
    Purpose of the Study:

    Companies change auditors for various reasons, however due to the costs associated with switching, it is often an indication of potential problems between the auditor and company. This study examines the effects that an auditor change has on bank loan contracting. Specifically, whether companies that switch auditors incur increased costs and more stringent nonprice terms on loans. The authors address two potential reasons of why an auditor change would lead to information risk, and subsequently higher costs on loans. The first is if creditors perceive that the auditor change is opportunistic, such as management trying to find a more compliant auditor. The second information risk is related to the new auditor’s lack of client-specific knowledge. Both of these risks would cause for audit quality to decrease and, therefore loan costs would increase. The authors also consider the type of switch and its effect on loan costs. The three types examined are from (Non)Big 4 to (Non)Big 4, Big 4 to Non-Big 4, and Non-Big 4 to Big 4.

    Design/Method/ Approach:

    The sample includes 312 pairs of auditor change companies and non-audit change companies from 1998-2014. The audit change information was gathered using Audit Analytics and the bank loan data was from DealScan. Additionally, the authors excluded all audit switches due to the collapse of Arthur Andersen in 2002. The authors utilize a difference-in-differences (DID) research design comparing loan spreads between auditor change companies (before and after switch) and non-audit change companies.

    Findings:

    Overall, the authors find that when companies initiate a loan within a year of changing auditors there is a 22% increase in loan costs.           

    Specifically, the authors find the following:

    • There is no significant difference in the incremental loan spread between the three types of auditor switches. This evidence suggests creditors place a stronger emphasis on the two information risks instead of the potential differences between Big 4 and Non-Big 4 audit quality.
    • There is still a substantial increase in information risk following the change regardless of whether the company initiates the auditor switch (dismissal) or the auditor resigns
    • There is a 13.65% increase in the probability that banks add collateral requirements following an auditor change. The upfront and annual fees also increase by an average of about 53% and 25% respectively.
    Category:
    Auditor Selection and Auditor Changes
    Home:

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