The Impact Of Debt Structure On Auditorchoice

We investigate the impact of a firm’s debt structure on its choice of an auditor. Auditor choice is measured along two dimensions: brand name reputation and auditor industry specialization. Debt structure includesdebt level and debt sources. We find that firms with high leverage are less likely to have brand name/specialist auditors, consistent with managerial opportunism. Prior studies document that brand name/specialist auditors are more effective at constraining income-increasing accruals. Because the likelihood and cost of covenant violations increase with leverage, firms avoid brand name/specialist auditors to keep their financial reporting flexibility. We further investigate whether the negative relation between auditor choice and client leverage differs between firms with only private debt and firms that also have access to the public debt market. While it holds for firms that have only private debt, the negative relation turns positive for firms that also have public debt. This difference suggests the dominant role of the debt contracting hypothesis for firms that have public debt. Firms bond themselves to brand name/specialist auditors to access the public debt market. This paper extends the auditor differentiation and auditor choice literature and contributes to the growing literature on the impact of the debt market on firms’ financial reporting attributes.