Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

research summary

    Auditor Quality and Debt Covenants
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 14.0 Corporate Matters 
    258 Views
    Title:
    Auditor Quality and Debt Covenants
    Practical Implications:

    This paper contains important applications for borrowing firms wanting to have more favorable loan contract terms. By hiring a high-quality auditor this decreases risks for the creditors and therefore oftentimes reduces the stringency of debt covenants. Subsequently, the borrowing firm will violate the debt covenants less.

    Citation:

    Robin, Ashok, Q. Wu, and H. Zhang. 2017. “Auditor Quality and Debt Covenants”. Contemporary Accounting Research 34.1 (2017): 154.

    Purpose of the Study:

    Debt covenants are in place to help mitigate information asymmetry and agency problems between lender and borrower. This study examines whether high-quality auditors decrease the lenders’ demand for strict covenants (contracting effect), therefore reducing the likelihood of covenant violations (violation reduction effect). The assumption is that the information provided by a high-quality auditor would lower information asymmetry and agency problems, and consequently there would be no reason for strict debt covenants. 

    Design/Method/ Approach:

    There was a sample of 35,181 observations from 1996-2007. Compustat was used to gather annual covenant-violation data and Deal Scan was used to gather U.S. loan facility information.  The authors used an ordinary least squared (OLS) regression model in the analysis.

    Findings:

    Overall, the authors find high-quality audits are in fact related with fewer and looser covenants in debt contracts.

    Specifically, the authors find the following:

    • As auditor quality increases the probability of financial covenant violations decrease. The probability is 1.45% lower for firms audited by industry experts and about 4.98% lower for firms audited by the Big 4.
    • High-quality auditors play a role in mitigating the adverse effect of covenant violations on corporate borrowing costs.
    Category:
    Audit Quality & Quality Control, Corporate Matters
    Home:

    http://commons.aaahq.org/groups/e5075f0eec/summary