Credit Default Swaps on Corporate Debt and the Pricing of Audit Services

52 Pages Posted: 28 Jun 2017  

Lijing Du

Towson University - Department of Finance

Adi Masli

University of Kansas - School of Business

Felix Meschke

University of Kansas - Finance Area

Date Written: June 27, 2017

Abstract

Previous studies document that lenders lack incentives to monitor borrowing firms or to make concessions during bankruptcy if these lenders insure against corporate default with credit default swaps (CDS). This article investigates whether external auditors increase their audit fees for those client firms that have their debt referenced by CDS. In a comprehensive sample of U.S. companies from 2001-2015 it finds that CDS-referenced companies incur larger audit fees compared to companies without CDS. The economic magnitude of the audit fee increase ranges from 5.4 percent to 11 percent, depending on the econometric specification employed. Deteriorating corporate conditions or other observable characteristics do not explain the positive association between CDS trading and audit fees, or the increase in audit fees following CDS initiations. The findings suggest that auditors increase their professional skepticism and monitoring efforts of CDS-referenced clients; they might also expect higher liability losses.

Keywords: credit default swaps (CDS), empty creditor problem, audit fees, auditing, pricing of audit services, client business risk, audit risk

JEL Classification: G10, G30, G33, G34

Suggested Citation

Du, Lijing and Masli, Adi and Meschke, Felix, Credit Default Swaps on Corporate Debt and the Pricing of Audit Services (June 27, 2017). Auditing: A Journal of Practice & Theory, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2993474

Lijing Du (Contact Author)

Towson University - Department of Finance ( email )

8000 York Road
Towson, MD 21252
United States

Adi Masli

University of Kansas - School of Business ( email )

1300 Sunnyside Avenue
Lawrence, KS 66045
United States

Felix Meschke

University of Kansas - Finance Area ( email )

Capitol Federal Hall
1654 Naismith Drive
Lawrence, KS 66045
United States
(347) 433-5495 (Phone)

HOME PAGE: http://www.business.ku.edu/faculty/meschke-felix/

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