Does Financial Statement Audit Reduce the Cost of Debt of Private Firms?

59 Pages Posted: 3 Jan 2014

See all articles by Jernej Koren

Jernej Koren

University of Ljubljana - Faculty of Economics

Urska Kosi

University of Paderborn; Vienna University of Economics and Business

Aljosa Valentincic

University of Ljubljana - Faculty of Economics

Date Written: January 2, 2014

Abstract

This study examines the effect of audit on private firms’ cost of debt. We use a sample of 1,949 small private firms operating in the period 2006-2010 with optional financial statement audit. High quality data allows us to construct a more precise interest rate measure than existing studies employ. After controlling for obvious sources of demand for voluntary audits (ownership complexity, subsidiary status, bank relations), we find a robust central result that voluntary audits increase rather than decrease the cost of debt financing, contrary to several existing studies. This finding indicates that voluntary audits are generally treated as “adopting a label” and penalised by creditors, regardless of the perceived auditor quality as a result of the lemon problem in the audit market. Even Big-4 audits increase the cost of debt, likely as a result due to the lemon problem in the audit market, although the increase is smaller than for non-Big-4 audits. The results are sensitive to the estimation method used (OLS, Heckman’s two-step, PSM) and (sub-)sample selection. We show that disregarding the underlying assumptions of these estimation methods may lead to incorrect inferences. Additional analyses show that audited firms’ reported earnings are less informative about future operating performance than earnings of their unaudited counterparts. Our results also indicate that results are sensitive to cost of debt definition and this might have affected the results reported in the existing literature.

Keywords: private firms, voluntary audit, cost of debt, self-selection bias, lemon problem

JEL Classification: M42, M41

Suggested Citation

Koren, Jernej and Kosi, Urska and Valentincic, Aljosa, Does Financial Statement Audit Reduce the Cost of Debt of Private Firms? (January 2, 2014). Available at SSRN: https://ssrn.com/abstract=2373987 or http://dx.doi.org/10.2139/ssrn.2373987

Jernej Koren

University of Ljubljana - Faculty of Economics ( email )

Kardeljeva ploscad 17
Ljubljana, 1000
Slovenia

Urska Kosi

University of Paderborn ( email )

Warburger Str. 100
Paderborn, D-33098
Germany

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria
+43 1 313365691 (Phone)

Aljosa Valentincic (Contact Author)

University of Ljubljana - Faculty of Economics ( email )

Kardeljeva ploscad 17
Ljubljana, 1000
Slovenia

Register to save articles to
your library

Register

Paper statistics

Downloads
354
Abstract Views
2,368
rank
82,742
PlumX Metrics