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The information role of audit opinions in debt contracting

Author

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  • Chen, Peter F.
  • He, Shaohua
  • Ma, Zhiming
  • Stice, Derrald

Abstract

This study examines the relevance of modified audit opinions (MAO) in private debt contracting. We use the auditor׳s explanatory language to partition MAOs into Inconsistency opinions, resulting from an accounting change or a restatement; and Inadequacy opinions, arising from a material uncertainty or a going concern (GC) opinion. Using the loan contracts of firms with MAOs, we find that, compared with loans issued in the year after a clean opinion, loans issued in the year after an MAO are associated with higher interest spreads (17 basis points on average), fewer financial covenants, more general covenants, smaller loan sizes, and a higher likelihood of requiring collateral. We find that the effect on loan spreads (as well as on other non-price terms) varies by the type of MAO, ranging from no effect for an accounting change to an average increase of 107 basis points for a GC opinion. Additional analyses of GC opinions find that auditors communicate incremental information to lenders about clients’ credit risk. Overall, our empirical results suggest that lenders incorporate the information contained in MAOs into debt contracting.

Suggested Citation

  • Chen, Peter F. & He, Shaohua & Ma, Zhiming & Stice, Derrald, 2016. "The information role of audit opinions in debt contracting," Journal of Accounting and Economics, Elsevier, vol. 61(1), pages 121-144.
  • Handle: RePEc:eee:jaecon:v:61:y:2016:i:1:p:121-144
    DOI: 10.1016/j.jacceco.2015.04.002
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    References listed on IDEAS

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    1. repec:eee:jaecon:v:64:y:2017:i:1:p:78-97 is not listed on IDEAS
    2. repec:eee:riibaf:v:42:y:2017:i:c:p:689-709 is not listed on IDEAS
    3. repec:kap:jbuset:v:150:y:2018:i:1:d:10.1007_s10551-016-3193-8 is not listed on IDEAS
    4. repec:hur:ijaraf:v:7:y:2017:i:4:p:121-127 is not listed on IDEAS
    5. Belén Gill de Albornoz Noguer & Simona Rusanescu, 2017. "Foreign ownership and financial reporting quality in private subsidiaries," Working Papers. Serie EC 2017-02, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).

    More about this item

    Keywords

    Debt contracting; Audit opinions; Going concern opinions; Explanatory language;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting
    • M49 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Other

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