Cost of Debt and Auditor Choice

• In Event: Financial Accounting and Reporting 9

Abstract

This paper examines whether auditor choice affects a firm’s cost of debt. Auditor choice is measured along two dimensions: brand name reputation and industry specialization. It further examines whether the source of debt matters in the relation. We find that the choice of a brand name or industry specialist auditor decreases a firm’s cost of debt in general. However, the additional impact of industry specialization is not significant when we analyze the relation using a sub-sample of Big N audited firm-years. For the sub-sample of non-Big N audited firm-years, engaging an industry specialist auditor appears to increase cost of debt. A further breakdown of the full sample into a sample with both public and private debt and a sample with only private debt provides more insight. For the sample with both public and private debt, engaging a brand name and specialist auditor decreases cost of debt. The result holds for industry specialization when a sub-sample of Big N audited firm-years is used. But for the sample with only private debt, engaging a specialist auditor increases cost of debt for both Big N audited firms and non-Big N audited firms. Our findings contribute to the literature in three ways. First, it provides additional evidence for the role of external auditing in reducing agency cost of debt with a more comprehensive dataset. Secondly, it shows difference between the two dimensions of auditor differentiation: brand name reputation and industry specialization. Thirdly, it shows that the choice of an industry specialist auditor has different impact on cost of debt for firms that have only private debt and firms that also have public debt.

Authors

• Fengyun Wu, Manhattan College

• Fang Sun, Hunter College

• Sherry Li, Rider University