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Auditor size, tenure, and bank loan pricing

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Abstract

Using a large sample of U.S. bank loan data from 1996 to 2008, we investigate the relation between two auditor characteristics, namely, auditor size and tenure, and loan interest rates. Our results show the following: First, we find that the loan interest rate is significantly lower for borrowers with prestigious Big 4 auditors than for borrowers with non-Big 4 auditors. Second, we find that auditor tenure is negatively associated with the loan interest rate, suggesting that a long client–auditor relationship lowers the loan borrowing cost. Third, we find that the negative association between auditor size and loan rate is more pronounced for transaction-based term loans than for relationship-based revolving loans. Fourth, our sub-period tests show that our results are driven by the post-Sarbanes–Oxley Act period. Our study provides direct evidence that auditor size and tenure are incremental credit risk-reducing factors in the bank loan market.

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Notes

  1. Bank loans have consistently accounted for more than 50% of total debt financing in the United States (Graham et al. 2008) since 1980. The volume of syndicated loans reached $1.69 trillion in 2007 according to the DealScan database.

  2. To our knowledge, three studies examine the role of audits per se in loan pricing. Johnson et al. (1983) provide experimental evidence suggesting that auditor association is not a significant factor affecting bank loan rates. Blackwell et al. (1998) investigate the economic value of various levels of audit assurance (i.e., audits, reviews, compilations) using a small sample private firms. Kim et al. (2011a) examine the effect of voluntary, non-statutory audits on interest expenses (relative to short- and long-term debts) using a sample of privately held Korean firms. Both Blackwell et al. (1998) and Kim et al. (2011a) report evidence that audits per se lead to a lower loan rate or a lower interest rate. However, none of the above studies investigate the relation between auditor size or tenure and bank loan rate.

  3. Lenders in the loan market include banks and other private lenders, such as investment banks, insurance companies, and other institutional investors. This paper uses the terms banks and lenders interchangeably, since commercial banks are the major suppliers of private debt.

  4. Another stream of literature (e.g., Fan and Wong 2005; Choi and Wong 2007; Hossain et al. 2010) investigates the corporate governance role of firms’ external auditors using the Big 4/non-Big 4 dichotomy.

  5. However, focusing on bonds issued by private firms via private placements, Fortin and Pittman (2007) fail to determine that choosing a higher-quality Big 4 auditor significantly affects credit rating and yield spread.

  6. For instance, a deal can comprise a line of credit facility and a term loan with longer maturity.

  7. Generally, accelerated filers are public companies that have been a public company for at least 12 calendar months, have filed at least one annual report, are not “small business issuers,” and have public float (the aggregate market value of the voting and non-voting common equity held by non-affiliates of the company) of $75 million or more. Non-accelerated filers must begin including the management’s assessment of internal control effectiveness in annual reports for fiscal years ending on or after December 15, 2007, and the auditor’s attestation in annual reports for fiscal years ending on or after December 15, 2008.

  8. In an additional test, we measure an auditor’s industry specialization based on its share of clients’ total assets in each two-digit SIC industry. Though not reported, the results are similar to those reported in Table 7.

  9. In our sample, all industry specialist auditors are Big 4 auditors.

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Acknowledgments

We are grateful to Cheng-Few Lee (the Editor-in-Chief) and two anonymous referees for their many insightful and constructive suggestions We appreciate helpful comments from Jong-Hag Choi, Annie Qiu, Hanina Shi, Cheong H. Yi, Suk Heun Yoon, Yoonseok Zang, and participants of the 2006 Annual Meeting of the American Accounting Association and PhD/DBA research seminars at the Hong Kong Polytechnic University and Seoul National University. J.-B. Kim and J. Tsui acknowledge partial financial support for this research obtained from the Competitive Earmarked Research Grant of the Hong Kong Special Administrative Region Government and the Area of Strategic Development Research Grant, Faculty of Business, Hong Kong Polytechnic University. B. Y. Song acknowledges partial financial support for this project from the Faculty Research Development Program, John Molson School of Business, Concordia University.

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Authors and Affiliations

  1. Department of Accountancy, College of Business, City University of Hong Kong, Kowloon, Hong Kong

    Jeong-Bon Kim

  2. Department of Accountancy, John Molson School of Business, Concordia University, 1455 De Maisonneuve Blvd. W., Montreal, QC, H3G 1M8, Canada

    Byron Yang Song

  3. School of Accounting and Finance, Faculty of Business, The Hong Kong Polytechnic University, Kowloon, Hong Kong

    Judy S. L. Tsui

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  1. Jeong-Bon Kim
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  2. Byron Yang Song
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Correspondence to Byron Yang Song.

 

 

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Kim, JB., Song, B.Y. & Tsui, J.S.L. Auditor size, tenure, and bank loan pricing. Rev Quant Finan Acc 40, 75–99 (2013). https://doi.org/10.1007/s11156-011-0270-z

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