Convertible Debt Usage and Audit Fees

• In Event: Audit Fees

Abstract

This study examines the association between audit fees and convertible debt usage. In particular, we test the hypothesis that convertible debt usage is associated with greater risk of material misstatement and higher audit fees than straight debt because of its greater complexity due to the potential impact on diluted EPS numbers. Consistent with our expectation, we find a positive association between proxies for convertible debt usage and audit fees and we find that the coefficient of convertible debt proxies is larger than that of straight debt proxies. Further, we find that the auditor’s effort on convertible debt is sensitive to managerial bonus incentives and market valuation incentives to avoid reporting lower diluted EPS numbers. In addition, we find that after (before) the passage of the Sarbanes-Oxley Act, auditors attach greater (lower) effort to convertible debt and less (more) effort to straight debt. However, we find limited evidence that SOX has affected auditors’ incorporation of managerial incentives to avoid reporting lower diluted EPS numbers in their risk assessment for convertible debt. Overall, our results suggest that auditors consider financing instruments characteristics in their assessment of risk of material misstatement for financial statement audit, consistent with the requirement of PCAOB AS 12 and SAS 109.

Authors

• Henri Akono, University of Maine - Orono

• Khondkar E Karim, University of Massachusetts-Lowell

• Heeick Choi, University of Massachusetts-Lowell