Auditor Communication Provisions in Private Loan Agreements: Do They Matter?

52 Pages Posted: 11 Aug 2019

See all articles by Lin Cheng

Lin Cheng

The University of Arizona - Eller College of Management

Jacob Jaggi

University of Arizona

Paul N. Michas

University of Arizona - Eller College of Management

Jeffrey W. Schatzberg

University of Arizona - Department of Accounting

Date Written: August 7, 2019

Abstract

We examine auditor communication provisions (ACPs) in private loan agreements, which are private contracting mechanisms between external auditors and audit clients which establish communication between lenders and their borrowers' auditors. We provide evidence that lenders value privately-contracted auditor communication and often specify multiple ACPs that facilitate lender monitoring. In terms of debt contracting outcomes, we find ACPs are associated with a lower ex ante likelihood of loan covenant violation. We also examine audit fee implications for the borrower and find that ACPs are associated with higher audit fees, which is consistent with auditors responding to the litigation risk these provisions impose. We corroborate this by providing evidence that this relationship is concentrated in samples where the risk of third-party litigation is greater. Finally, we find evidence that ACPs lead auditors to become more conservative as their clients exhibit lower signed discretionary accruals when the risk of third-party litigation is greater.

Keywords: Loan agreements, Auditor communication provisions, Information asymmetry, Auditor litigation risk, Audit fees, Auditor conservatism

JEL Classification: M42, D82, G21, G30, K40

Suggested Citation

Cheng, Lin and Jaggi, Jacob and Michas, Paul N. and Schatzberg, Jeffrey W., Auditor Communication Provisions in Private Loan Agreements: Do They Matter? (August 7, 2019). Available at SSRN: https://ssrn.com/abstract=3433846 or http://dx.doi.org/10.2139/ssrn.3433846

Lin Cheng

The University of Arizona - Eller College of Management ( email )

McClelland Hall, Room 301Q
1130 E. Helen Street
Tucson, AZ 85721
United States

Jacob Jaggi

University of Arizona ( email )

Tucson, AZ 85721
United States

Paul N. Michas (Contact Author)

University of Arizona - Eller College of Management ( email )

Tucson, AZ 85721
United States

Jeffrey W. Schatzberg

University of Arizona - Department of Accounting ( email )

McClelland Hall 301
Tucson, AZ 85721
United States
520-621-2238 (Phone)
520-621-3742 (Fax)

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