Is More Always Better? Disclosures in the Expanded Audit Report and their Impact on Loan Contracting.

• In Event: Auditor Report Change, Auditor Materiality

Abstract

Starting October 2013 auditors of premium listed firms in the UK are mandated to prepare an expanded audit report. In this report auditors provide details on audit procedures, main risks of material misstatement (RMMs), and materiality thresholds. We analyze if the increased audit disclosure reduces private lenders’ monitoring costs and shapes loan contracting. Our evidence suggests that the introduction of the expanded audit report is associated with improved lending terms for adopting firms relative to matched samples of non-adopting US and UK firms. The analyses of expanded audit reports in the post-adoption period show that borrowers with more RMMs are perceived to be riskier, which translates into less favorable loan contracting terms. Additional tests indicate that uncertainty in the tone of the disclosures reduces the negative impact of the number of RMMs on lending terms. Taken together, our results indicate that the expanded audit report disclosures contain relevant information, which shapes loan contracting.

Authors

• Vlad Andrei Porumb, University of Groningen

• Yasemin Zengin Karaibrahimoglu, University of Groningen

• Reggy Hooghiemstra, University of Groningen

• Dick de Waard, University of Groningen