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    Voluntary Audits and the Cost of Debt Capital for Privately...
    research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 12.0 Accountants’ Reports and Reporting, 15.0 International Matters 
    Voluntary Audits and the Cost of Debt Capital for Privately Held Firms: Korean Evidence.
    Practical Implications:

    Initial audits, changing audit status of a private company from no audit to either voluntary or mandatory audit, lead to a significant reduction in the interest rate on debt. The results show that an external audit is of informational value in the pricing of private debt such as bank loans, presumably. It enhances the credibility of audited financial statements, and thus helps banks and other private lenders overcome information problems related to borrower credit quality.


    Kim, J., Simunic, D. A., Stein, M. T., & Yi, C. H. 2011. Voluntary Audits and the Cost of Debt Capital for Privately Held Firms: Korean Evidence. Contemporary Accounting Research 28 (2): 585-615.

    private companies, capital costs, debt capital
    Purpose of the Study:

    The authors aim to provide systematic evidence on the value of an external audit per se in the pricing of private debt. Their primary objective is to investigate whether voluntary audits by independent auditors are associated with a reduction in the interest rate on the company’s debt.

    The Korean environment provides a useful setting in which to examine the economic value of an external audit for several reasons. To assess the value of an external audit per se, researchers must observe a similar no-audit case as the reference point of comparison. However, the no-audit base case is not available for the usual sample of public companies, because all publicly traded companies are subject to the statutory requirement of mandatory external audits.

    • In Korea the no-audit base case is available for privately held companies. Currently, private Korean companies with total assets of less than 7 billion South Korean won (about U.S. $7 million) are not required to have their financial statements audited by independent auditors. Nevertheless, some private companies voluntarily purchase external audit services.
    • Private Korean companies rely heavily on bank financing. This allows us to approximate the interest rate on borrowing for each company, using the ratio of aggregate interest expenses to the average of short- and long-term debt during the year.
    • Korea is one of the few countries for which detailed financial statement data is publicly available for a large sample of privately held companies.
    Design/Method/ Approach:

    The initial sample for this study consists of privately held companies that are included in the KIS-DATA database, developed by the largest credit rating agency in Korea, Korea Investors Services. Included in the sample are private companies with no audits and those with voluntary audits.  The authors obtain a total of 72,577 firmyear observations over the 19872002 period, of which 69,661 have no audit and 2,916 have voluntary audits.

    • Private companies with voluntary audits pay significantly lower interest rates on their debt than do private companies with no audit.
    • The results of the regressions show that the average interest cost savings from a voluntary audit range from about 56 to 124 basis points for the full sample and from about 16 to 36 basis points for the reduced sample, depending on the regression method used, and these amounts are economically significant.
    • The appointment of a Big 4 auditor does not lead to a greater reduction in the interest cost of borrowing, compared with the appointment of nonBig 4 auditors. This result is consistent with the view that what matters more to banks and other private lenders is audit presence (audit versus no audit) rather than auditor choice.
    • A first-time audit status change from no audit to voluntary audits leads to a greater interest cost saving than a first-time status change from no audit to mandatory audits. The change analyses provide evidence suggesting that voluntary audits are better able to enhance the credibility of audited financial statements than mandatory audits in the market for private debts such as bank loans.
    Accountants' Reporting, International Matters