Do Auditors Play a Positive Role in the Resolution of Debt Covenant Violations?

42 Pages Posted: 25 Oct 2012

See all articles by Liangliang Jiang

Liangliang Jiang

Hong Kong Polytechnic University

Hui Zhou

University of Melbourne - Melbourne Business School

Date Written: October 15, 2012

Abstract

We investigate whether auditors exercise closer monitoring and thus charge higher fees in response to debt covenant violations. Using a hand-collected sample focusing on initial covenant violations, we document that audit fees experience an average increase of about 20 percent in the year immediately following the violation year and continue to stay at a high level until three years after the initial violation. Difference-in-differences analysis shows that the increase in audit fees in response to covenant violations is more (less) pronounced when the benefit (cost) of closer auditor monitoring is likely to be higher. Further analysis links the observed increase in audit fees with the improvement in audit committee independence and diligence in response to covenant violations. Our findings provide new evidence that auditors play a positive role in the resolution of debt covenant violations and highlight the importance of corporate governance factors in the audit process.

Keywords: corporate governance, debt covenant, audit committee, audit fee

JEL Classification: M40, M41

Suggested Citation

Jiang, Liangliang and Zhou, Hui, Do Auditors Play a Positive Role in the Resolution of Debt Covenant Violations? (October 15, 2012). Available at SSRN: https://ssrn.com/abstract=2166174 or http://dx.doi.org/10.2139/ssrn.2166174

Liangliang Jiang (Contact Author)

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

Hui Zhou

University of Melbourne - Melbourne Business School ( email )

200 Leicester Street
Carlton, Victoria 3053 3186
Australia

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