Auditors' Reputation Damage and the Cost of Bank Debt: Evidence from Litigation against Auditors

69 Pages Posted: 1 Aug 2018 Last revised: 26 May 2020

See all articles by Jong-Hag Choi

Jong-Hag Choi

Seoul National University - College of Business Administration

Wonsuk Ha

Seoul National University

Hanna Lee

University of Maryland - Robert H. Smith School of Business

Byron Y. Song

Hong Kong Baptist University (HKBU) - Department of Accountancy & Law

Date Written: May 26, 2020

Abstract

This study examines how auditors’ reputational damage caused by litigation affects audit clients’ borrowing costs. Focusing on a sample of syndicated loans made to non-litigated borrowers, we find that borrowing costs are higher when the firms’ auditors are sued for alleged audit failures. However, this positive association is significantly attenuated when syndicate participant banks have a prior lending relationship with the borrower, when they repeatedly interact with the lead bank through other loan transactions, or when they are more willing to join the syndicate. Furthermore, loans to the clients of litigated auditors include more general covenants and fewer accounting-based performance pricing provisions. Collectively, our findings suggest that private lenders such as banks, on average, incorporate auditors’ reputation damage in assessing the credit risk of their borrowers. This study provides important insights into the externalities of litigation against auditors in the context of private debt contracting and lending relationships.

Keywords: Auditor litigation; auditor reputation; cost of debt; syndicated loans; lending relationship

JEL Classification: M41, M42

Suggested Citation

Choi, Jong and Ha, Wonsuk and Lee, Hanna and Song, Byron Y., Auditors' Reputation Damage and the Cost of Bank Debt: Evidence from Litigation against Auditors (May 26, 2020). Available at SSRN: https://ssrn.com/abstract=3223582 or http://dx.doi.org/10.2139/ssrn.3223582

Jong Choi (Contact Author)

Seoul National University - College of Business Administration ( email )

Seoul, 151-742
Korea, Republic of (South Korea)

Wonsuk Ha

Seoul National University ( email )

Kwanak-gu
Seoul, 151-742
Korea, Republic of (South Korea)

Hanna Lee

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

Byron Y. Song

Hong Kong Baptist University (HKBU) - Department of Accountancy & Law ( email )

Kowloon Tong, Kowloon
Hong Kong

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