Trade Credit and Audit Risk

• In Event: Continental Breakfast - RESEARCH INTERACTION FORUM
  In Roundtable Session: Research Interaction Forum

Abstract

Trade credit provides customer information to trade creditors because of its short maturity and frequent renewal, helping trade creditors monitor their customer firms. Creditor monitoring reduces audit risk because it improves the internal control quality and reduces agency costs. In addition, trade credit gives an incentive to trade creditors to insure their customer firms against liquidity shock because the loss of a customer could be disastrous (e.g., losing receivables and relationship-based investments), reducing customer firms’ liquidity risk and auditors’ inherent risk. Using audit fees as a proxy for audit risk and a difference-in-differences research design with the exogenous shock created by The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, I find that trade credit is negatively associated with audit risk. Cross-sectional tests suggest that the monitoring role related to trade credit is the potential channel through which trade credit impacts audit risk.

Author

• Bo Ren, University of Connecticut