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Auditor Quality and Debt Covenants

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  • Ashok Robin
  • Qiang Wu
  • Hao Zhang

Abstract

This study examines the impact of auditor quality on financial covenants in debt contracts. We conjecture that high†quality auditors have two related effects on these debt covenants: (i) they encourage fewer and less restrictive covenants by providing assurance to lenders at contract inception and, consequently, (ii) they ensure a lower probability of eventual covenant violations. Consistent with the conjectures, we find that auditor quality is negatively associated with the intensity and tightness of financial covenants. Specifically, high†quality auditors are associated with fewer covenants (especially performance covenants) and less binding covenants. Additionally, we find that auditor quality is negatively associated with the likelihood of covenant violations. In an ancillary test, we provide evidence that high†quality auditors mitigate the detrimental effect of covenant violations on the cost of borrowing. Together, these findings highlight the important role of auditors in debt contracting.Les auteurs s'intéressent à l'incidence de la qualité du service offert par les auditeurs sur les clauses restrictives d'ordre financier des contrats d'emprunt. Selon leurs hypothèses, le recours à des auditeurs offrant un service de qualité supérieure a deux répercussions connexes sur les clauses restrictives : i) il favorise la réduction du nombre et de la rigueur des clauses restrictives en rassurant les bailleurs de fonds au moment de la conclusion du contrat et, corollairement, ii) il diminue la probabilité de violations des clauses restrictives. Conformément à ces hypothèses, les auteurs constatent que la qualité du service offert par les auditeurs est en relation négative avec le nombre et la rigueur des clauses restrictives d'ordre financier. Plus précisément, les auditeurs offrant un service de qualité supérieure sont associés à un moins grand nombre de clauses restrictives (en particulier les clauses relatives à la performance) et à des clauses restrictives moins contraignantes. De plus, les auteurs observent que la qualité du service offert par les auditeurs est en relation négative avec la probabilité de violation des clauses restrictives. Un test secondaire révèle que les auditeurs qui offrent un service de qualité supérieure atténuent ainsi les répercussions défavorables de la violation de clauses restrictives sur les coûts d'emprunt. Dans leur ensemble, ces constatations mettent en lumière l'importance du rôle des auditeurs dans le recours à l'emprunt.

Suggested Citation

  • Ashok Robin & Qiang Wu & Hao Zhang, 2017. "Auditor Quality and Debt Covenants," Contemporary Accounting Research, John Wiley & Sons, vol. 34(1), pages 154-185, March.
  • Handle: RePEc:wly:coacre:v:34:y:2017:i:1:p:154-185
    DOI: 10.1111/1911-3846.12243
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    Cited by:

    1. Nguyen, Lily & Vu, Le & Yin, Xiangkang, 2020. "The undesirable effect of audit quality: Evidence from firm innovation," The British Accounting Review, Elsevier, vol. 52(6).
    2. Guangming Gong & Liang Xiao & Si Xu & Xun Gong, 2019. "Do Bond Investors Care About Engagement Auditors’ Negative Experiences? Evidence from China," Journal of Business Ethics, Springer, vol. 158(3), pages 779-806, September.
    3. Pappas, Kostas & Walsh, Eamonn & Xu, Alice Liang, 2019. "Real earnings management and loan contract terms," The British Accounting Review, Elsevier, vol. 51(4), pages 373-401.
    4. Xiaomei Han & Wei Luo & Liansheng Wu & Wei Zhou, 2023. "Audit Effort and Stock Price Crash Risk," Abacus, Accounting Foundation, University of Sydney, vol. 59(1), pages 230-257, March.
    5. Abu Amin & Blake Bowler & Mostafa Monzur Hasan & Gerald L. Lobo & Jiri Tresl, 2020. "Firm Life Cycle and Cost of Debt," CERGE-EI Working Papers wp665, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    6. Mansi, Sattar A. & Qi, Yaxuan & Wald, John K., 2021. "Bond covenants, bankruptcy risk, and the cost of debt," Journal of Corporate Finance, Elsevier, vol. 66(C).
    7. Chy, Mahfuz & De Franco, Gus & Su, Barbara, 2021. "The effect of auditor litigation risk on clients' access to bank debt: Evidence from a quasi-experiment," Journal of Accounting and Economics, Elsevier, vol. 71(1).
    8. Li, Tongxia & Lu, Chun & Routledge, James, 2023. "Brand capital on debt maturity structure," Journal of Contemporary Accounting and Economics, Elsevier, vol. 19(3).
    9. Kershen Huang & Chenguang Shang, 2024. "Does informal governance matter to institutional investors? Evidence from social capital," The Financial Review, Eastern Finance Association, vol. 59(2), pages 433-457, May.
    10. Mihai Carp & Costel Istrate, 2021. "Audit Quality under Influences of Audit Firm and Auditee Characteristics: Evidence from the Romanian Regulated Market," Sustainability, MDPI, vol. 13(12), pages 1-16, June.
    11. Hou, Fei & Shen, Huayu & Wang, Ping & Xiong, Hao, 2023. "Signing auditors' cultural background and debt financing costs," International Review of Financial Analysis, Elsevier, vol. 87(C).
    12. Amin, Abu & Bowler, Blake & Hasan, Mostafa Monzur & Lobo, Gerald J. & Tresl, Jiri, 2023. "Firm life cycle and cost of debt," Journal of Banking & Finance, Elsevier, vol. 154(C).

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