COMPONENT AUDITORS AND LENDERS’ PERCEPTION OF AUDIT QUALITY
Posted: 13 Jan 2020 Last revised: 14 May 2020
Date Written: May 13, 2020
While non-U.S. auditors audit a significant proportion of U.S.-based clients, until recently, lenders were largely unaware of the involvement of component auditors since the U.S.-based lead auditor was not required to disclose information about participating auditors. Using the disclosure under Form AP mandated by the PCAOB, we find that the increase in cost of debt ranges from 15 basis points to 22 basis points when component auditors are used relative to engagements that do not involve component auditors. We also find that cost of debt is greater when the component auditor has GAAP-related audit deficiencies and fewer CPAs, face PCAOB disciplinary orders or more frequent inspection, and when the lead auditor and the component auditors are not from the same Big 4 audit networks. These findings are consistent with the notion that lenders associate lower audit quality and higher information risk with certain attributes of component auditors. Further, the component auditor’s superior local knowledge mitigates cost of debt for firms with high foreign operations. We also conduct an event study and find an adverse bond market reaction around the first-time disclosure of Form AP.
Keywords: component auditor; Form AP; cost of debt; audit quality; earnings persistence
Suggested Citation: Suggested Citation