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    Investor Protection, Firm Informational Problems, Big N...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.11 Impact of Firm and External Inspection Programs, 15.0 International Matters 
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    Title:
    Investor Protection, Firm Informational Problems, Big N Auditors, and Cost of Debt around the World.
    Practical Implications:

    This study shows that Big N auditors are more effective in reducing the cost of debt in countries with strong investor protection. In particular, the authors find that high-quality auditors are perceived by creditors as providing higher-quality audits in strong investor protection countries other than the U.S., including the U.K. and Canada. The study has implications for policy makers because it suggests that auditors (and, perhaps, auditing standards) may not be effective in weak investor regimes. High-quality auditors may be less effective in performing a governance role without the support of a strong investor protection regime. 

    Citation:

    Gul, F. A., G. S. Zhou, and X. K. Zhu. 2013. Investor Protection, Firm Informational Problems, Big N Auditors, and Cost of Debt around the World. Auditing: A Journal of Practice & Theory 32 (3): 1-30.

    Keywords:
    audit quality, cost of debt, information asymmetry, informational problems, investor problems
    Purpose of the Study:

    In this paper, the authors first confirm that auditor quality reduces the cost of debt across countries. Next, they examine (1) the joint effect of investor protection and auditor quality on the cost of debt across countries, and (2) whether informational quality affects this relationship. The authors investigate the question of whether, in an international setting, firms with more informational problems are more likely to benefit from high-quality auditors and/or strong investor protection than firms with fewer informational problems.

    The authors are motivated to examine these issues because of four factors.

    • First, although prior studies using U.S. data have documented a link between the choice of Big N auditors and lower cost of debt, these findings have focused on the U.S., where auditors are exposed to high levels of litigation risks. It is unclear whether the relationship holds in jurisdictions with low litigation risks.
    • Second, there are competing views of the relationship between the effectiveness of Big N auditors and countrywide governance regimes in international settings.
    • Third, prior international studies on the role of auditor quality have not recognized that firms with higher levels of informational problems may benefit more from auditor quality and/or stronger investor protection than do firms with lower levels of informational problems.
    • The final motivation for the study lies in the importance of debt in corporate financing for firms across countries.
    Design/Method/ Approach:

    The auditor and financial data are obtained from the Compustat Global Industrial and Commercial file. The data on analysts are obtained from the Institutional Brokers’ Estimate System (I/B/E/S). The investor protection data are extracted from LLSV and LLS. The other macroeconomic data are collected from the World Bank. There are 96,396 observations from 30 countries for the period from 1994 to 2006.

    Findings:
    • The results show that firms with Big N auditors are significantly and negatively associated with the cost of debt. 
    • Big N auditors play a role in reducing a firm’s cost of debt across all countries.
    • The results show that the relationship between Big N auditors and the cost of debt is stronger in stricter investor protection regimes.
    • The authors find that firms with higher informational problems benefit more from high-quality auditors in terms of lower cost of debt in stronger investor protection countries.
    • The results suggest that in weaker investor protection countries, creditors seem to price firms’ information asymmetry problems in the cost of debt, and Big N auditors do not seem to play an effective role in reducing debt-monitoring costs.
    Category:
    Audit Quality & Quality Control, International Matters
    Sub-category:
    Impact of Firm & External Inspection Programs