Voluntary Audits and the Cost of Debt Capital for Privately Held Firms: Korean Evidence

Abstract

Using a large sample of privately held Korean companies that are not required to obtain an external audit, this paper examines the value of voluntary external audits of financial statements with respect to the cost of debt. We find that private companies with an external audit pay a significantly lower interest rate on their debt than do private companies without an audit. However, we find no significant difference in the interest rate on debt between Big 4-audited and non-Big 4-audited companies. Finally, using a subset of sample firms that changed their engagement status from no audit to voluntary or mandatory audit, we find that the status change from no audit to being audited – either voluntarily or because the audit becomes mandatory as firms become sufficiently large to trigger a statutory audit – leads to significant savings in the interest cost of borrowing. Overall, our results suggest that external audit per se is of information value in the pricing of private debt in an environment where external audits are not mandatory.

Keywords: Voluntary audit, private companies, cost of debt, private debt pricing, Korea