The Value of Verification in Debt Financing: Evidence from Private U.S. Firms

Abstract

I examine how verification of financial statements influences debt pricing. I use a large proprietary database of privately-held U.S. firms, an important business sector in which the information environment is opaque and financial statement audits are not mandated. I find that audited firms have a significantly lower cost of debt and that lenders place more weight on audited financial information in setting the interest rate. Further, I provide evidence of a mechanism for this increased financial statement usefulness: accruals from audited financial statements are better predictors of future cash flows. Collectively, I provide novel evidence that audited financial statements are more informative and that this significantly influences lenders’ decisions.

Keywords: Verification, Auditing, Debt Financing, Private Firms, Earnings Persistence

JEL Classification: D82, G20, L14, M42