Financial Constraints, Auditing, and External Financing

• In Event: Audit and Firm Financing

Abstract

This paper investigates whether financially constrained firms use costly audit signals to facilitate their access to external financing. We document that in the face of higher financial constraints, firms produce more reliable financial statements with lower restatement and fraud likelihood, pay higher audit fees, and have their audit opinion reports completed sooner. We then examine whether paying higher audit fees and having shorter audit lags enable firms facing higher financial constraints to raise more financing. Analyzing the implications of external auditing in equity and debt markets separately reveals that having costlier and timelier audits facilitates equity-seeking constrained, but not debt-seeking constrained, firms’ access to financing. While our findings may initially seem at odds with those of prior studies that associate financially constrained firms with possibly aggressive accounting choices, our study and prior ones agree that the documented results are driven by financially constrained firms’ desire to communicate positive signals to investors rather than mislead them.

Authors

• Ahmet Kurt, Bentley University

• Rani Hoitash, Bentley University

• Udi Hoitash, Northeastern University

• Mary Becker, Canisius College