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Lending relationships, auditor quality and debt costs

Author

Listed:
  • Monika Causholli
  • W. Robert Knechel

Abstract

Purpose - The purpose of this paper is to examine the circumstances under which high quality audits reduce a firm's cost of debt. The paper extends previous research by Pittman and Fortin by considering how auditor quality relates to the capital cycle and industry of the firm. Design/methodology/approach - The paper uses a sample of US initial public offerings (IPOs) from 1986 to 1998 to analyze a firm's debt costs for the five years following the IPO. The paper uses a firm's private age as a proxy for its capital cycle and existing banking relationships to capture the likely extent of debt dependence prior to IPO. The authors separately analyze technology firms from other firms. Findings - Consistent with prior literature, it is found that firms that are young at the time of an IPO pay higher interest rates and auditor quality plays a significant role in lowering the cost of debt financing. Consistent with the hypotheses made, the authors also observe that the effect of auditor quality is larger for firms in the high tech industry sector. Further, the relationship between auditor quality and age depends on industry, with the benefits of hiring a high quality auditor primarily accruing to younger tech firms and older non-tech firms. Originality/value - While the issue of auditor quality and cost of debt has been examined by previous researchers, the additional insight that the effect of auditor quality depends on both capital cycle (age) and industry of a firm, increases understanding of the circumstances under which the audit of financial statements is socially desirable and economically valuable to investors and other stakeholders.

Suggested Citation

  • Monika Causholli & W. Robert Knechel, 2012. "Lending relationships, auditor quality and debt costs," Managerial Auditing Journal, Emerald Group Publishing, vol. 27(6), pages 550-572, June.
  • Handle: RePEc:eme:majpps:v:27:y:2012:i:6:p:550-572
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    References listed on IDEAS

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    1. Ongena, Steven & Smith, David C., 2001. "The duration of bank relationships," Journal of Financial Economics, Elsevier, vol. 61(3), pages 449-475, September.
    2. Pittman, Jeffrey A. & Fortin, Steve, 2004. "Auditor choice and the cost of debt capital for newly public firms," Journal of Accounting and Economics, Elsevier, vol. 37(1), pages 113-136, February.
    3. Sattar A. Mansi & William F. Maxwell & Darius P. Miller, 2004. "Does Auditor Quality and Tenure Matter to Investors? Evidence from the Bond Market," Journal of Accounting Research, Wiley Blackwell, vol. 42(4), pages 755-793, September.
    4. Eugene F. Fama, 2002. "Testing Trade-Off and Pecking Order Predictions About Dividends and Debt," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 1-33, March.
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    11. Titman, Sheridan & Trueman, Brett, 1986. "Information quality and the valuation of new issues," Journal of Accounting and Economics, Elsevier, vol. 8(2), pages 159-172, June.
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    17. João A. C. Santos & Andrew Winton, 2008. "Bank Loans, Bonds, and Information Monopolies across the Business Cycle," Journal of Finance, American Finance Association, vol. 63(3), pages 1315-1359, June.
    18. Houston, Joel F & James, Christopher M, 2001. "Do Relationships Have Limits? Banking Relationships, Financial Constraints, and Investment," The Journal of Business, University of Chicago Press, vol. 74(3), pages 347-374, July.
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    Citations

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    Cited by:

    1. Persakis, Anthony & Iatridis, George Emmanuel, 2015. "Cost of capital, audit and earnings quality under financial crisis: A global empirical investigation," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 38(C), pages 3-24.
    2. Joshy,Jacob & Desai, Naman & Agarwalla, Sobhesh Kumar, 2015. "Are Big 4 Audit Fee Premiums Always Related to Superior Audit Quality? Evidence from India’s Unique Audit Market," IIMA Working Papers WP2015-03-10, Indian Institute of Management Ahmedabad, Research and Publication Department.

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