Fair Value Accounting and the Cost of Debt: The Role of Auditor Expertise

Abstract

This study examines the association between fair value accounting and the cost of debt, proxied by bond yield spread. After controlling for potentially confounding factors, such as a firm’s credit rating and other underlying risks, we find that the application of fair value accounting is generally associated with a higher bond yield spread, primarily driven by Level 3 estimates. These results support the argument that fair value accounting undermines the reliability of financial statements. In addition, we explore the moderating role of auditor industry expertise at both the national and the city levels. Our results show that national-level auditor industry expertise is associated with lower bond yield spreads for Level 1 and Level 3 fair value inputs, whereas the impact of city-level auditor industry expertise on bondholders is mainly on Level 3 fair value inputs. Furthermore, we explore the effect of auditor expertise on task-specific fair value and find that city-level auditor expertise lowers bond yield spread for firms that use Level 3 fair value inputs. These results hold after controlling for the exogenous shock, i.e., Auditing Standard Change in Accounting Estimates (Auditing Standard 2501, PCAOB 2017).

Keywords: Fair Value Accounting, The Cost of Debt, Bond Yield Spread, Auditor Industry Expertise, Auditor Fair Value Expertise

JEL Classification: M41, M42