Equity-Debt Agency Costs and Demand for Audit Quality

• In Event: Demand for Audits and/or High-quality Audits

Abstract

This study explores a 1991 legal ruling that extended managerial fiduciary duties to debtholders for near-insolvent Delaware firms to examine the causal relation between incentives to mitigate equity-debt agency costs and demand for audit quality. Using both auditors’ propensity to issue a going-concern opinion and firms’ likelihood of hiring a BigN auditor to measure audit quality, our difference-in-differences tests show that audit quality increases significantly after the ruling for near-insolvent Delaware firms relative to near-insolvent non-Delaware firms. Further, we find that the increase in audit quality is more pronounced for the near-insolvent Delaware firms facing higher equity-debt agency conflicts prior to the ruling. These results are consistent with incentives to mitigate equity-debt agency costs creating an economic demand for high quality audit.

Authors

• Santhosh M Ramalingegowda, University of Georgia

• Liang Tan, George Washington University

• Yong Yu, University of Texas at Austin