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Auditor Quality, Tenure, and Bank Loan Pricing

By Jeong-Bon Kim, Byron Y. Song and Judy S. L. Tsui

Current Draft March 2007

____________ The first author is at Concordia University and The Hong Kong Polytechnic University. The second and third authors are at The Hong Kong Polytechnic University. We thank Jong-Hag Choi, Annie Qiu, Hanina Shi, Cheong H. Yi, Suk Heun Yoon, Yoonseok Zang, and participants of the 2006 Annual Meeting of AAA, and Ph.D./DBA research seminars at The Hong Kong Polytechnic University, and Seoul National University for their useful comments. The first and last authors acknowledge partial financial support for this research obtained from the Competitive Earmarked Research Grant of The Hong Kong SAR Government and the Area of Strategic Development (ASD) Research Grant, the Faculty of Business, The Hong Kong Polytechnic University. All errors are our own. Correspondence: Judy Tsui, Chair Professor and Dean, the Faculty of Business, The Hong Kong Polytechnic University, Hung Hom, Kowloon, Hong Kong (fbjt@inet.polyu.edu.hk).

Electronic copy available at: http://ssrn.com/abstract=873598

Auditor Quality, Tenure, and Bank Loan Pricing

SUMMARY: Using a large sample of US bank loan data over the 9-year period from 1996 to 2004, we investigate the effect of two auditor characteristics, namely auditor quality and tenure, on the price term of bank loan contracts. Our results show the following: First, we find that banks charge a significantly lower rate for borrowers with Big 4 auditors than for borrowers with non-Big 4 auditors. Further analysis shows that banks charge a higher loan rate for borrowers who change their auditors in general, and they charge a substantially higher loan spread for borrowers who downgrade their auditors from Big 4 to nonBig 4 auditors in particular. Second, we find that the loan spread is inversely related to auditor tenure, suggesting that banks view auditor tenure as a credit risk-reducing factor. Third, we find that the relation between loan spread and audit quality is conditioned upon the level of credit risk perceived by credit rating agencies. Our study provides direct evidence that banks take into account audit quality when assessing borrowers’ credit quality and determining the price term of loan contracts. Keywords: Auditor quality; Auditor tenure; Loan pricing; Loan spread; Private debt.

Electronic copy available at: http://ssrn.com/abstract=873598

Auditor Quality, Tenure, and Loan Pricing

INTRODUCTION Audited financial statements play a crucial role in facilitating financial contracts in general and loan contracts between lenders and borrowers in particular. However, previous research has paid little attention to the role of audit quality in loan contracting, although audit quality is an important factor determining the credibility and quality of audited financial statements. In particular, no previous research has examined the issue of whether audit quality differentiation between Big 4 (previously 5, 6, or 8) and non-Big 4 auditors does matter in the market for private debts such as bank loans, though Big 4 audits have been documented to be of greater value to participants in the equity and bond markets, compared with non-Big 4 audits (e.g., Mitton 2002; Mansi et al. 2004; Pittman and Fortin 2004). 1 Given the lack of empirical evidence on the role of audit quality in private debt contracting, this study aims to provide systematic evidence on whether two auditor characteristics, i.e., auditor quality and tenure, influence the price term of loan contracts. To do so, we first investigate whether the loan rate that lenders charge to borrowers are lower for borrowers with Big 4 auditors than for those with non-Big 4 auditors after controlling for borrowers’ credit quality and loan-specific characteristics. Second, we investigate whether and how auditor tenure, measured by the length of the auditor-client relationship, affects loan pricing.

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To our knowledge, there are three studies that examine the role of audit per se in loan pricing. Johnson et al. (1983) provide experimental evidence suggesting that auditor association is not a significant factor affecting the bank loan rate. Blackwell et al. (1998) investigate economic values of varying levels of audit assurance (i.e., audits, reviews, compilations), using a small sample of 212 private (closely held) firms that have revolving credit arrangements with six banks located within a single state in the US. Kim et al. (2005) examine the effect of voluntary, non-statutory audits on the interest expenses (relative to short-term and long-term debts) using a sample of privately held Korean firms. Both Blackwell et al. (1998) and Kim et al. (2005) report evidence that audit per se leads to a lower loan rate or a lower interest rate. However, none of the above studies examine the issue of audit quality differentiation in loan pricing for publicly held borrowers.

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between the loan rate and two auditor characteristics.A series of recent incidents of audit failures that started with the 2001 Enron debacle and the subsequent Andersen collapse have triggered a world-wide debate over whether the long-term auditor-client relationship potentially leads to the impairment of auditor independence and thus audit quality.. In this paper. if any.e.. 2003).g. Previous research suggests that the information intermediation by credit rating agencies helps outside investors reduce the information asymmetry. Myers et al. no previous research has examined whether and how lenders take into account auditor tenure when assessing borrowers’ credit worthiness and setting the price term of loan contracting. i. Davis et al. several researchers have examined the effect of auditor tenure on audit and earnings quality (e. our analysis focuses on whether the loan rate-reducing effect. we aim to provide direct evidence on the effect of auditor tenure on loan pricing. Further analysis shows that lenders charge a higher loan rate for borrowers who change -2- . 2004. of auditor quality and tenure differs systematically between borrowers with good credit ratings and those with poor credit ratings. as a supplemental analysis. Mansi et al. For this purpose.g. however.. if any. 2005). Finally. 2002. we also examine whether the relation. 2004) and lowering a cost of capital from the bond markets (e. Our regression results reveal the following. First. we find that lenders charge a significantly lower loan rate for borrowers with Big 4 auditors than for borrowers with non-Big 4 auditors. It is therefore interesting to examine how the audit quality variables interact with the information intermediation variable in the context of loan pricing. auditor quality and tenure. which in turn contributes to increasing firm valuation (Lang et al. Since the enactment of the Sarbanes-Oxley Act of 2002 which called for a study and review of the potential effects of requiring mandatory rotation of audit firms. is conditioned upon information intermediation and monitoring activities by credit rating agencies. To our knowledge.

when borrowers have poor credit ratings. our findings provide useful insights into the role of auditor quality and tenure in the market for private debts such as bank loans. we find that the loan rate is inversely related to auditor tenure. suggesting that lenders view auditor tenure as a credit risk-reducing factor. We provide evidence that the quality of external audits is an additional factor that favorably impacts the price term of loan contracting. This suggests that high-quality audits are of greater value to lenders when borrowers are faced with high credit risks. and they charge a substantially higher loan rate for borrowers who downgrade their auditors from Big 4 to non-Big 4 auditors in particular. in particular. namely auditor quality and tenure. Overall. and that this positive effect is not subsumed by information intermediation and monitoring activities by credit rating agencies. The remainder of the paper is structured as follows: In section 2. Our study also contributes to the existing loan contracting literature as well.their auditors in general. we specify an empirical model linking the loan spread with our test variables. and borrower-specific and loan-specific control variables. In section 4. Second. In section 3. Our evidence is consistent with the view that lenders view higher-quality audits and longer tenure as credit risk-reducing factors. our empirical evidence is consistent with the view that audit quality plays a more important role in loan pricing. we describe our sample and data sources and present descriptive statistics -3- . this is the first study that documents direct evidence that banks take into account auditor quality and tenure when assessing borrowers’ credit quality and setting the loan rate. we find that the loan rate-reducing effect of audit quality is greater for borrowers with low credit ratings than for borrowers with high credit ratings. we develop our research hypotheses. Our study adds to the existing auditing literature in the following ways. Given the scarcity of empirical evidence on the issue. To our knowledge. Finally.

Bank loan officers typically rely on audited financial statements to assess borrowers’ credit quality. skill and resources to collect. HYPOTHESIS DEVELOPMENT The Effect of Auditor Quality on Loan Pricing Banks are the largest providers of private debts and bank loans are the most important source of external finance for most firms around the world. In section 8. Section 5 reports the results of our univariate tests. We also examine whether the loan rate-audit quality relation is conditioned on credit risk perceived by credit rating agencies. and analyze relevant information and to assess the credibility of financial reports and the credit worthiness of a borrower. the use of highquality auditors enhances the credibility of audited financial statements. On the other hand. Therefore banks are likely to charge a lower loan rate for borrowers with Big 4 auditors than for borrowers with non-Big 4 auditors. banks themselves are more sophisticated information processors. In section 7. -4- . Section 6 reports the results of multivariate tests.on our variables. produce. In other words. for example. Moreover. which in turn reduces lenders’ monitoring costs. On one hand. compared with a representative investor in the stock and/or public debt (bond) markets. we perform further analysis to investigate the impact of auditor changes on loan pricing. through direct communications with management. the information-enhancing value of high-quality audits. we conduct a variety of robustness check for our main regression results. One may thus argue that the value of high-quality auditors may not be as high to banks as it is to investors in the equity and bond markets. Banks have the ability. banks often have access to private information about the borrower. The final section provides summary and concluding remarks. and thus alleviates information asymmetries between lenders and borrowers.

it is an empirical issue whether or not the use of Big 4 auditors by borrowers has an incremental value to banks. Choi and Doogar (2005) show that auditors with long tenure are less likely to issue going concern opinions. Given the two conflicting views on the value of auditor quality in the bank loan market. The Effect of Auditor Tenure on Loan Pricing There are two conflicting views on the relation between auditor tenure and audit quality. In this scenario. In such a case. other things being equal. mandatory auditor rotation may contribute to improving audit quality by truncating the existing auditorclient relationship. there would be no significant difference in loan rates charged to borrowers with Big 4 auditors vis-à-vis those with non-Big 4 auditors.if any. suggesting that audit quality decreases with the length of the auditor-client relationships. may be subsumed by the superior ability of banks to acquire. -5- . auditor independence erodes. and monitor credit quality and/or renegotiate loan contract terms subsequent to changes in credit quality (after loans are granted). Davis et al. and thus client firms are given more flexibility in financial reporting. when banks assess borrowers’ credit quality (before loan decisions are made). verify and process borrowerspecific information and to assess the credibility and quality of borrowers’ financial statements. To provide empirical evidence on the issue. which is at the center of current debates over the pros and cons of mandatory auditor rotation. we test the following hypothesis with no prediction on the directional effect: H1: The loan rate charged by banks differs systematically between borrowers with Big 4 auditors and borrowers with non-Big 4 auditors. (2002) provide evidence suggesting that discretionary accruals increase with auditor tenure. One strand of research argues that as auditor tenure increases.

(2002) and Geiger and Raghunandan (2002) also provide evidence suggesting a positive association between auditor tenure and audit quality in the context of reporting quality and the likelihood of a bankrupt firm receiving a going concern audit opinion. suggesting a positive relation between auditor tenure and audit quality. Ghosh and Moon (2005) find that the magnitude of earnings response coefficients increases with auditor tenure. Using several accrual measures as proxies for earnings quality (and thus audit quality). (2004) document an inverse relation between auditor tenure and the cost of debt financing in the public bond market (measured by bond yield spreads over the benchmark yield). -6- .tenure auditors and borrowers with short-tenure auditors. respectively. Mansi et al. 2 To our knowledge. (2003) document a positive relation between audit quality and auditor tenure. no previous research has examined the effect of auditor tenure on audit quality in the context of bank loan pricing. we test the following hypothesis with no prediction on the directional effect: H2: The loan rate charged by banks differs systematically between borrowers with long. however. other things being equal. Myers et al.The other strand of research argues that audit quality increases with auditor tenure. EMPIRICAL MODEL To investigate the effect of auditor quality and tenure on bank loan pricing. To provide empirical evidence on whether and how banks take into account auditor tenure when assessing borrowers’ credit quality and setting the loan rate. and provides evidence supporting a positive association between audit quality and auditor tenure. we specify the following regression model: AIS = α 0 + α1 Big + α 2Tenure + β 1 Size + β 2 Leverage + β 3 MB + β 4 LogCoverageRatio + β 5CurrentRatio + β 6 Pr ofitability + β 7Tangibility + β 8 Beta + β 9 Loss + γ 1 LogMaturity + γ 2 LogLoanSize + γ 3 Syndicate + ( LoanPurposesDummies) + ( IndustryDummies) + (YearDummies ) + ErrorTerm (1) 2 Johnson et al.

. Current Ratio. Coopers & Lybrand. and is paid by the borrower on all drawn lines of credit. i.. PricewaterhouseCoopers. and merged entities among them. Arthur Young. This all-in spread represents the interest rate charged by banks (plus annual fee and the upfront or maturity fee) over the benchmark rate. α1 < 0 ). the dependent variable. Commercial banks typically assess the risk of a loan based upon the information on the business nature and performance of borrowing firms. The AIS variable thus reflects the banks’ perceived level of risk on a loan facility provided to a specific borrower. Our test variables. and its magnitude captures the difference in the loan spreads charged to borrowers with Big 4 auditors vis-à-vis those with non-Big 4 auditors. To isolate the loan pricing effect of audit quality from the effect of other borrowers’ characteristics.e. and then set a markup over a prevailing benchmark rate such as LIBOR to compensate for the credit risk. Leverage. Big is a dummy variable which is equal to 1 if the incumbent auditor of a borrowing firm is one of Big 4 (or previously 5. Deloitte & Touche. AIS.e. Tenure is measured by the number of years of the auditor-client relationship. 6 or 8) auditors which include Arthur Andersen. To the extent that Big 4 auditors are better able to help banks overcome the information problem. i. KPMG Peat Marwick. respectively.In Equation (1). We measure the cost of loan using a spread over LIBOR because most bank loans are priced in terms of the floating rate. is the cost of the bank borrowing which is measured by the drawn all-in spread in basis points.e.. α2 < 0 (α2 > 0). Touche & Ross.e. represent auditor quality and tenure. Size. we include a set of borrower-specific variables that are deemed to affect borrowers’ credit quality and thus loan pricing. one would observe a negative coefficient on Tenure i. MB. Log -7- . we expect the coefficient on Big to be negative (i. if banks view longer (shorter) tenure as being associated with higher (lower) audit quality. Big and Tenure. For example. LIBOR.. Ernst & Young. and 0 otherwise.

The Size variable is measured by the natural log of total assets. β1 < 0) because large firms are likely to have the better capacity to repay the loan. β4 < 0). Similar to Bharath et al.. Profitability. we expect that banks charge lower loan rates for more liquid firms. and thus have higher credit quality.e. Tangibility. We therefore expect a positive coefficient on Leverage (i. taxes. In such a case...e. To the extent that MB proxies for the growth opportunities.. Beta. growing firms are often faced with high risk. (2006). To obtain -8- .e. The Current Ratio variable denotes the ratio of current assets to current liabilities. We therefore do not predict the sign of the coefficient on MB. banks are likely to charge a higher loan rate for highleverage firms than for low-leverage firms. The Profitability variable is measured by EBITDA divided by total assets. and Loss.e. property and equipment (PP&E) to total assets.Coverage Ratio. and is measured by the market value of equity plus the book value of debt divided by the book value of total assets. depreciation and amortization (EBITDA: Compustat data item 13) to interest expenses. The Leverage variable is measured by the ratio of long-term debt to total assets. However. one would observe a positive AIS-MB relation. one would expect a negative relation between AIS and MB. and thus have lower credit quality. and β7 < 0. We expect a negative coefficient on Size (i. We expect a negative coefficient on this variable because banks are likely to charge a lower interest rate for firms with a better ability to repay the debt (i. β5 < 0. β2 > 0). while the Tangibility variable by the ratio of plant. respectively) because such firms have lower credit risks. β6 < 0. The Log Coverage Ratio variable denotes the natural log of one plus the interest coverage ratio which is measured by the ratio of earnings before interest. Firms with high leverage are likely to have higher default risks. The Beta variable denotes the market-model estimate of security beta. more profitable firms and firms with more tangible assets (i. To compensate for this potential credit risk. We include the MB variable to control for borrowers’ growth potentials.

we include Loan Purpose Dummies to control for any difference in loan pricing associated with the different purposes of loan facilities. We include this variable to capture any difference. 3 Our sample includes loan facilities with 22 different purposes specified by the LPC Dealscan database. We expect a positive coefficient on both Beta and Loss. in the interest rate charged between the syndicate and non-syndicate loans. 2006). Bharath et al. Strahan 1999. CP backup. we include Industry Dummies and Year Dummies to control for potential differences in the loan spreads across industries and over years. Dennis et al. debt repayment. -9- . Previous research on bank loan contracts shows that several loan-specific characteristics are related to the interest rate charged by banks (e. 2006).g. that is. if any. 3 Finally. respectively (e. We therefore expect a positive sign on Log Maturity and a negative sign on Log Loan Size (γ1 > 0 and γ2 < 0. Loss is a dummy variable which is equal to 1 for loss firms and 0 otherwise. Bae and Goyal 2003. The Syndicate variable is a dummy variable that equals 1 for the syndicate loans and 0 otherwise. Bharath et al. working capital.. respectively). we estimate the market model for each year using daily returns on an individual stock and the equally-weighted market returns. namely Big and Tenure. The Log Maturity variable is the natural log of the loan maturity period (in months). LBO/MBO.Beta for each year. The number of loan facilities with each of these seven purposes exceeds one percent of our sample. takeover. Previous research provides evidence that banks charge a higher interest rate for the longer-term loan and for the smaller loan facility. We use only seven Loan Purpose dummies to capture the seven most common purposes. corporate purposes. The Log Loan Size variable is measured by the natural log of the amount of loan facility given to a borrower. We include in Equation (1) a set of loan-level variables to isolate the potential effect of loan characteristics on the loan spread from the effect of our test variables.g. 2000. while the number of loan facilities with each of the other purposes is less than one percent of our sample. In addition. acquisition line.

8 This procedure leads to a substantial reduction in the number of available loan facilities because many borrowers included in the Dealscan database are subsidiaries of public firms. we also estimate our main regressions using only one facility within each deal and each firm year. . but excludes bridge loans and non-fund based facilities such as lease and standby letters of credit. revolvers and 364-day facilities.e. 5 For instance. a loan contract between a borrower and bank(s) at a specific date. in particular. Dichev and Skinner 2002). Dichev and Skinner (2002). 6 As will be further discussed in Section 7. 4 The database includes the loan data starting from 1986. (2006).10 - . Each deal. (2005). and expands its coverage over time. Bharath et al. Beatty and Weber (2003). may have only one facility or have a package of several facilities with different price and non-price terms. (2006). i. DATA SOURCES.SAMPLE. 7 Our sample selection criteria are similar to those used by Bharath et al. 1996-2004. 6 Our sample includes term loans. We also require that all loan facilities in our sample are senior debts. 8 We require that all the relevant annual accounting data of borrowers are available in the fiscal year immediately before 4 Other papers which use the LPC Dealscan database include Strahan (1999). AND DESCRIPTIVE STATISTICS The initial list of our sample consists of all publicly traded firms with bank loan data that are included in the LPC Dealscan database during the sample period. The LPC Dealscan database is an online database which contains a variety of historical bank loan data and other financial arrangements that are compiled from the Securities and Exchange Commission (SEC) filings by public firms and self-reporting by banks.. The loan data in the LPC Dealscan database are compiled for each deal and facility. after 1995. and find that the results remain qualitatively identical with those using each facility as a separate observation. etc. using the ticker symbol and name of each borrower. Asquith et al. private firms and government entities rather than publicly traded companies. 7 We then match the loans with borrowers’ financial statement data in Compustat. Thus we select 1996 as the starting year of our sample period. a deal may comprise a line of credit facility and a term loan with longer maturity. 5 We consider each facility as a separate observation in our sample since many loan characteristics and the loan spreads vary across facilities. and some public companies are not covered by Compustat (Strahan 1999.

(Insert Table 1 here) Panel A of Table 2 provides descriptive statistics on various characteristics of loan facilities in our sample. (2006) sample except for the size of the loan facility. As shown in the table. The mean and median of loan facilities size are $313 and $146 millions (in US dollars) with a large standard deviation of $652 million.5 and $50 millions). After applying the above procedures.656 loan facilities in our sample are for revolvers. we obtained a sample of 7. The loan characteristics in our sample are.e. reflecting the fact that our sample period includes more recent years and the facility size has increased over time.the loan year. About 93 percent of the loan facilities are syndicate loans with an average of more than nine different lenders (commercial banks and other financial institutions such as investment banks and insurance companies) in a syndicate group underwriting the loan facilities. AIS) are 172 and 150 basis points. The mean (median) maturity period is about 41 (36) months with its standard deviation of about 24 months. The large standard deviation of AIS relative to its mean indicates a wide variation in AIS across loan facilities and deals. comparable with those of the Bharath et al.656 loaned facilities borrowed by 1. respectively. the mean and median of the drawn all-in spread over LIBOR (i. The mean and median of loan facility size in our sample is much bigger than those in their sample ($177. reflecting an increase in the Dealscan coverage.11 - . Table 1 presents the distribution of loan facilities in our sample by year and loan type. The number of loan facilities increases with years. nearly 57 percent of 7. suggesting that its distribution is skewed with a wide variation across loan facilities and deals.. respectively. (Insert Table 2 here) . while about 23 percent and 20 percent are for term loans and 364-day facilities. with its standard deviation of about 130 basis points. As shown in Panel A.911 firms over the 1996-2004 period. by and large.

while they are 252 and 250 basis points. As shown in Panel A. the market-to-book ratio of 1. The mean and median of the Size variable are 6. respectively.000 years.150. with its standard deviation of 1. As shown in Panel B. respectively..157 years. RESULTS OF UNIVARIATE TESTS To assess the effect of auditor quality (Big 4 vs. 95. the length of the auditor-client relationship in years) are 8. for the Big 4 sample. measured by the natural log of one plus the interest coverage ratio.446 years and 8.893. The descriptive statistics on Profitability and Tangibility show that for our sample. respectively. . PP&E). and (2) the non-Big 4 sample of borrowers with non-Big 4 auditors. and 18.753.775 and 6. EBITDA and tangible assets (i.e.e.1 percent of all firm-years are audited by Big 4 auditors.Panel B of Table 2 presents descriptive statistics on borrowers’ characteristics in our sample. The mean and median of Tenure (i. with its standard deviation of 5.. on average. The Log Coverage Ratio variable.818. for the non-Big 4 sample. has the mean (median) of 2.12 - . the mean and median of the drawn all-in spread (AIS) are 168 and 150 basis points.9 percent of total assets are. Our sample firms have.2 percent. along with the results of tests for the mean and median differences between the two samples (t-test and Wilcoxon z-test. security beta close to one. On average. our sample firms have the long-term debt-to-total asset ratio of 26. respectively.969) with a standard deviation of 1. non-Big 4 auditors) on loan pricing. we partition the full sample into two sub-samples: (1) the Big 4 sample of borrowers with Big 4 auditors. Panel A of Table 3 reports descriptive statistics on our major research variables separately for the Big 4 sample and for the non-Big 4 sample. respectively.4 percent of our sample firms have experienced a loss during the sample period. suggesting that the Tenure variable is reasonably distributed in our sample. respectively).5 percent and 34. 14. and the current ratio of 1.753.177 (1.

we observe that the mean and median of Size. compared with those in the non-Big 4 sample. suggesting that. respectively. on average. Current Ratio. and Loss between the two sub-samples. MB. The mean and median of Tenure are 8. Profitability. have a larger loan facility. on average. With respect to a set of nine variables representing borrowers’ characteristics (Size to Loss). borrowers in the Big 4 sample. On average.833 and 5. for the Big 4 sample. borrowers in the Big 4 sample are larger. considering the mean and median of AIS for the full sample are 172 and 150 basis points. have a higher market-to-book ratio and a lower current ratio. and are more likely to have a syndicate loan. for the non-Big 4 sample. while they are 5. With respect to a set of four variables representing loan characteristics. To assess the effect of auditor tenure on loan pricing.000 years.13 - .581 and 8. we observe no significant difference in the mean and median of Log Coverage Ratio. we partition the full sample into two sub-samples on the basis of the median tenure of 8 years: (1) the long-tenure sample of borrowers with their auditor tenure longer than or equal to eight years. These mean and median differences are significant at less than the one percent level. respectively. and (2) the short-tenure .Both the mean and median differences of 84 and 100 basis points are significant at less than the onepercent level. Leverage.000 years. and attract more participant lenders. respectively (as reported in Table 2). suggesting that banks charge a significantly lower loan rate for borrowers with Big 4 auditors than for borrowers with non-Big 4 auditors. more tangible assets and a higher beta. compared with borrowers in the non-Big 4 sample. more leveraged. Big 4 auditors have a longer tenure than non-Big 4 auditors. However. Tangibility and Beta are significantly different between the Big 4 and non-Big 4 samples at less than the one percent level. These differences are economically significant as well.

and attract more participant lenders. are significant at less than the one percent level. along with the results of tests for the mean and median differences between the two sub-samples. Panel B of Table 3 reports descriptive statistics on our major research variables separately for the long-tenure sample and for the short-tenure sample.sample of borrowers with their auditor tenure less than eight years. Both the mean and median differences of 57 and 89 basis points. With respect to a set of nine variables representing borrowers’ characteristics. on average. our data reveal that the loan spread decreases significantly with auditor tenure. respectively (as reported in Table 2). and have a lower current ratio. for the short-tenure sample. borrowers in the long-tenure sample. while 93. while they are about 202 and 200 basis points. With respect to a set of four variables representing loan characteristics.14 - . more tangible assets. considering the mean and median of AIS for the full sample are 172 and 150 basis points. 96. are more likely to have a syndicate loan. (Insert Table 3 here) . respectively. a smaller beta. suggesting that banks take into account auditor tenure when assessing the credibility of financial statements and setting the loan rate. respectively. those in the long tenure sample are larger in size. In short. on average.1 percent in the short-tenure sample. for the long-tenure sample. These differences are economically significant as well. there are significant differences in their mean and median values of most variables between the longtenure and short-tenure samples. respectively. Compared with borrowers in the short-tenure sample. This difference is significant at less than the one percent level. have a shorter maturity period and a larger loan facility. compared with those in the short-tenure sample. and a lower likelihood of incurring a loss. As shown in Panel B.9 percent of borrowers in the long-tenure sample have Big 4 auditors. the mean and median of AIS are about 145 and 111 basis points.

However.15 - .14 and -0.83. Size is highly correlated with Log Loan Size with the magnitude of 0. and Tangibility suggest that banks charge a lower loan rate for borrowers with low credit risks. and Loss support the view that banks charge a higher loan rate for borrowers with high credit risks.Table 4 reports Pearson correlation coefficients among all the variables included in Equation (1). respectively.23. MB. With respect to the correlations among explanatory variables in Equation (1). This is as expected because banks are highly likely to offer large loan facilities to large firms. The positive correlations of AIS with Leverage. Current Ratio.56 between Log Coverage Ratio and Leverage. Beta. The correlations between other explanatory variables in Equation (1) are reasonable with the highest correlation of -0. Consistent with our expectation. In the next section. AIS is positively correlated with Log Maturity and negatively correlated with Syndicate. the significant differences in the borrower-specific and loan-specific variables between the Big 4 and non-Big 4 samples and between the long-tenure and short-tenure samples suggest that the effect of these variables on loan pricing should be controlled for when assessing the impact of auditor quality and tenure on the loan spread. we . This suggests that banks charge a lower (higher) loan rate for short-term (long-term) loans and syndicate (non-syndicate) loans. Log Coverage Ratio. (Insert Table 4 here) In summary. suggesting that the use of Big 4 auditors and long tenure auditors is inversely associated with a lower loan spread. respectively. Consistent with the results of our univariate tests in Table 3. the results of univariate tests suggest that banks charge a lower loan rate for borrowers with Big 4 auditors or long tenure than those with non-Big 4 auditors or short tenure. The negative correlations of AIS with Size. AIS is negatively correlated with Big and Tenure at less than the one percent level with their magnitude of -0. Profitability.

As shown in Column (3). As reported in Table 2. on average. As shown in Columns (1) and (2) of the table. RESULTS OF MULTIVARIATE TESTS USING THE FULL SAMPLE Table 5 presents the results of the OLS regressions in Equation (1) using the full sample of 7. In Column (3).557 (t = -2.5 years. the coefficient on Big (Tenure) is significantly negative when AIS is regressed on Big (Tenure) and other control variables.therefore conduct multivariate tests to isolate the loan pricing effect of auditor quality and tenure from the effect of borrower-specific and loan-specific characteristics.656 facility-years over the 1996-2004 period. suggesting that banks charge a lower loan rate for borrowers with Big 4 (long-tenure) auditors after controlling for all other borrower-specific and loan-specific variables. Our results support the view that highquality audits alleviate the information asymmetry between lenders and borrowers and the associated monitoring costs. borrowers . the average amount of loan facility is about $313 millions for our sample and the mean maturity is about 41 months or 3. when both Big and Tenure are included in the regression. This means that.16 - .26). (2004) who document that external audits by Big 4 auditors and long-tenure auditors lead to a reduced cost of debt in the public bond market and Pittman and Fortin (2004) who document that Big 4 audits are associated with a lower interest cost of debt in early public years of IPO firms. the coefficients on Big and Tenure are both significant with negative signs. indicating that the difference in loan spread between borrowers with Big 4 and non-Big 4 auditors is nearly 14 basis points. the coefficient on Big is -13. which in turn contributes to lowering the loan spread charged by banks. The above results are consistent with the view that banks take into account auditor quality and tenure when assessing borrowers’ credit quality and setting the loan spread. our results are consistent with Mansi et al. Overall.

200 per year over the maturity period of 3. on average. The associated amount of interest cost saving is about $40. AIS is significantly and positively associated with Leverage.with Big 4 auditors can save the interest cost of about $438. the coefficient on Tenure is -1. (2006). Our analyses in Table 5 consider each loan facility as an independent observation although a borrower can obtain several facilities in the same year. Columns (1) to (3) of . In Column (3). Beta. In addition. we find all coefficients except for MB and Syndicate are significant at less than the one percent level with their signs consistent with our expectations and the findings of previous research such as Bharath et al.267 (t = -5. (Insert Table 5 here) With respect to the coefficients on control variables. while it is negatively associated with Size. suggesting that.690. As a sensitivity check. AIS is positively associated with Log Maturity and negatively associated with Log Loan Size.3 basis points by retaining their relationship with the incumbent (Big 4 or non-Big 4) auditor for one additional year. and Loss. borrowers can save an interest rate of around 1. More specifically. (ii) including only one facility for each firm year (the largest facility in the first deal in each year). we use the following ways to reconstruct our sample and then re-estimate Equation (1): (i) including only one facility of each deal (the largest facility in terms of facility size). Profitability. ROBUSTNESS CHECKS We perform several sensitivity tests to check the robustness of our main results reported in Table 5. which is economically significant as well.17 - . Log Coverage Ratio.5 years. and Tangibility. Current Ratio. (iii) conducting Fama-MacBeth regressions on the reduced sample constructed in (ii).52).

HighAnalyst is a dummy variable which is equal to 1 for firms followed by more than sevem (the median) analysts and zero for firms followed by less than seven analysts or not covered by IBES.559 from 7. we estimate a probit auditor-choice model. MB is the market-to-book ratio. Sale is the natural log of net sales. Big 4 vs. the use of oneyear lagged values for our test variables does not alter our results reported in Table 5. are distorted by the existence of potential endogeneity problems. the error term in Equation (1) is likely to be correlated with whether borrowers choose Big 4 auditors or not. The sample size used for estimating Equation (2) as well as Equation (1) with the Inverse Mills ratio included reduces to 7. 9 In the second stage. In our regression specification in Equation (1).Table 6 report the corresponding results. As shown in Column (4) of the table.e. Shrinc is a dummy variable which is equal to one if the number of shares outstanding increases by more than 10 percent during the current fiscal year and zero otherwise. Margin is income before extraordinary items divided by net sales. we estimate the two-stage treatment-effect model (Greene 2000). namely Big and Tenure. and our estimate of the coefficient on Big is likely to be biased. and then obtain the Inverse Mills ratios.18 - . To address a concern over this potential self-selection bias. Liability is total liabilities divided by total assets.656 facility-year observations . the loan spread is linked to borrowers’ auditor choice (i. we re-estimate Equation (1) using one-year lagged values of Big and Tenure. suggesting that our earlier results are robust to potential endogeneity problems associated with our test variables. The magnitude. sign. Invtrating is a dummy variable which is equal to one for borrowers with S&P investment grade rating (BBB. Turnover is net sales divided by total assets. To further check whether our inferences on the test variables. In the first stage.or above) and zero for firms with non-investment grade rating or without rating value. Invrev is the sum of inventory and receivables over total assets. DP is depreciation and amortization over total assets. In such a case. and significance of the coefficients on Big and Tenure in Table 6 are similar to those in Table 5.. we then estimate Equation (1) after 9 The probit auditor-choice model is specified as follows: Big = α 0 + α 1 Sale + α 2 Liability + α 3 MB + α 4Tangibilit y + α 5 Invrev + α 6 DP + α 7Turnover + α 8 M arg in + α 9 Invtrating + α 10 HighAnalys t + α 11 Shrinc + ( Industries Dummies ) + (YearsDummi es ) + ε (2) Where Big is an indicator variable which is equal to one for borrowers with Big 4 auditors and zero otherwise. non-Big 4) and many other variables. Suppose that borrowers with high credit quality (and thus having lower AIS) are more likely to choose Big 4 auditors. Tangibility is net PP&E divided by total assets.

Not reported is that the inclusion of the loan type dummies does not alter our main results reported in Table 5. The result indicates that banks charge a higher loan spread for secured loans by the amount of about 71 basis points because we lose some observations due to missing values required for estimating Equation (2). which takes the value of one for secured loans and zero otherwise.including the Inverse Mills ratio (obtained in the first stage) as an additional independent variable. we estimate Equation (1) after including an additional dummy variable.19 - . revolvers less than one year and 364-day facilities. i. compared with those reported in Column (3) of Table 5. term loans. Though not tabulated.e. We find that the coefficient on Secured is significantly positive with its magnitude of 70. . suggesting that self-selection bias may not exist. First.950 and its t-value of 23. Overall. revolvers greater than one year. Column (5) of Table 6 reports the result of the second-stage regression. We find that the coefficient on Inverse Mills Ratio is significantly positive at less than five percent level. The coefficients on Big and Tenure are significantly negative at less than one percent level. we estimate Equation (1) after including the Loan Type dummies to distinguish among different types of loan facilities in our sample. Second. For brevity. This suggests that our main regression results reported in Table 5 (without including the Inverse Mills ratio) are robust with respect to potential selfselection biases. Though not reported. Secured.70. we also conduct several additional sensitivity checks. we find that the inclusion of this Secured dummy does not alter our main results presented in Table 5. the inclusion of the Inverse Mills ratio strengthens our result in the sense that the coefficients on Big and Tenure reported in Column (5) of Table 6 are more significantly negative and larger in magnitude. the estimation results of auditor-choice model are not reported here.

we also estimate Equation (1) after including the Performance Pricing dummy which equals one for loans with performance pricing provisions and zero otherwise. We also find that the coefficient on Performance Pricing is significantly negative with its magnitude of -30. we find that the coefficient on this dummy variable is significantly negative. Myers et al. (2000) and Berger and Udell (1990) who find that banks are more likely to require collaterals for borrowers with high credit risk and to charge higher rates for secured loans than for unsecured loans. We also use a dummy variable which equals one if the tenure for a firm year is longer than the median tenure in our sample (eight years) and zero otherwise. The results using this reduced sample remain qualitatively similar to those reported in Table 5.than for unsecured loans. Ghosh and Moon 2005. 2003. we measure auditor tenure by the number of years of the auditor-client relationship. Though not reported.20 - .. (2005).g. 2004). a finding consistent with Asquith et al. 10 Third.09. the loan rate is allowed to decrease directly with the improvement in credit quality. In short. Not reported is that the inclusion of the Performance Pricing dummy in Equation (1) does not alter our main results presented in Table 5. potential endogeneity problems associated with auditor 10 This finding is consistent with Dennis et al. Mansi et al. In addition. .719 and its t-value of -13. Finally. This suggests that banks charge a lower rate for loans with the performance pricing provision by the amount of 31 basis points than loans without it. in our analyses so far. we construct a reduced sample of borrowers with at least five years of auditor tenure and re-estimate Equation (1) using this reduced sample. following the procedure suggested by prior research on auditor tenure (e. our main results reported in Table 5 are robust to a variety of sensitivity checks such as alternative treatments of multiple loan facilities of each deal and for each firm year. Under a typical performance pricing provision. and then re-estimate Equation (1) using this new measure of auditor tenure. potential residual cross correlation.

1 to year t. by the change in the natural log of average dollar amount of all loan facilities for a firm from year t .e. we measure the change in loan maturity. After applying the above definitions of the change variables. a change from a Big 4 auditor to a non-Big 4 auditor. We use five different auditor change dummies. ∆Log Loan Size. i. ∆AIS.21 - .974 observations available to this change analysis. by the change in the facility-sizeweighted average of AIS on all loan facilities for a firm from year t .. we measure the change in the drawn all-in spread. i. by the change in the natural log of facility-size-weighted average of maturity periods (in months) for all loan facilities for a firm from year t . i.. there are 388 observations of all . a change within Big 4 auditors. In so doing.1 to year t. We do not include the change in Syndicate for our changes regressions because it is difficult to identify the Syndicate status for the yearly facility-size-weighted average loan. and a change within non-Big 4 auditors.e.. Out of 2. and the inclusion of various indicator variables representing Loan Type. We measure the change in loan facility size. we examine the relation between changes in auditors and changes in loan spreads. ∆Log Maturity. Downgrade.quality and tenure.. i.e. respectively. Similarly. ∆Big and ∆NonBig to capture any type of auditor change.e.974. (Insert Table 6 here) FURTHER ANALYSES The Impact of Auditor Changes on Bank Loan Pricing To alleviate a concern that our levels results so far are possibly driven by correlated omitted variables and to examine the effect of auditor switches on the change in the loan spread.1 to year t. Upgrade. we obtain a total of 2. a change from a non-Big 4 auditor to a Big 4 auditor. Change. Secured. and Performance Pricing.

However. we include Change to capture the effect of (any type of) auditor changes on the loan spread change.32) as reported in Columns (3) and (4). Consistent with our expectation. and 14 changes within non-Big 4 auditors.32) in Columns (3) and (4). respectively. which is significant at less than the one percent and five percent levels. i. In other words.33) and 79. which is economically significant as well.e..897 (t= 2. the coefficients on Downgrade are 79. the coefficient on Change is 12. banks charge a significantly higher rate for clients with auditor downgrading than for those with auditors switches within non-Big 4 auditors .types of auditor changes which include seven observations of upgrade changes. instead of Change. respectively.671 and 11. respectively. 353 changes within Big 4 auditors. In Columns (3) and (4). banks perceive auditor changes as an event that deteriorates the quality and/or credibility of accounting information. and thus they charge a higher loan spread for borrowers with auditor changes. on average.087. banks perceive auditor switches within non-Big 4 auditors to be a credit qualitydeteriorating event.. two loan-specific control variables (i. ∆Big and ΔNonBig. Downgrade.27) and 59. banks charge a higher loan spread for borrowers who switch their auditors from Big 4 to non-Big 4 auditors by the amount of nearly 80 basis points. This suggests that. respectively.1 to year t. we include the dummy variables indicating four types of auditor changes. This suggests that similar to auditor downgrading. As shown in Columns (3) and (4). Also the coefficients on ∆NonBig are 60. ΔLog Maturity and ΔLog Loan Size) are excluded in Columns (1) and (3). As a sensitivity check.22 - .e.440 (t = 2. 14 observations of downgrade changes. but they are included in Columns (2) and (4).917 (t = 2. Upgrade. In Columns (1) and (2).230 (t = 2. Table 7 presents the results of change regressions where all variables are measured in terms of their changes from year t . As reported in Columns (1) and (2) of the table. the coefficients on Upgrade and ∆Big are insignificantly positive.

To address this question. They also find that the favorable effect of auditor tenure on the bond yield spread is more significant for the non-investment-grade sample than for the investment-grade sample. Christensen et al. but is insignificant for the investment-grade sample. . We investigate whether the effect of audit quality on lowering the loan spread is greater for high-risk firms than for low-risk firms.g. Mansi et al.by the amount of about 20 basis points. (2004) find that the favorable effect of auditor quality on the bond yield spread is significant for the non-investment-grade sample. The results here are in sharp contrast with those reported by Mansi et al.275). this item is named as S&P Senior Debt Rating.23 - . 1998. Prior to September 1. our results are consistent with the finding of Fried and Schiff (1981) that there is a negative stock price reaction to auditor switches including the switch from a small to a large auditor. namely: (1) the investment-grade sample of borrowers with their S&P Issuer Bond Rating of BBB. Moreover.or above (N =2. and (2) the non-investment-grade sample of 11 The Issuer Credit Rating (ICR) is a current opinion of an issuer’s overall creditworthiness apart from its ability to repay individual obligation and focuses on the obligor’s capacity and willingness to meet its long-term financial commitments. 11 We then partition the full sample into two sub-samples. Their study suggests that the value of high-quality audit in the public bond market is more pronounced for high-risk firms than for low-risk firms. Beneish 1997. (2004) that only the auditor upgrade leads to a significant decrease in bond yield spreads. However.. (Insert Table 7 here) Effect of Credit Rating Previous research provides evidence that the information uncertainty is greater for highrisk firms than for low-risk firms (e. 1999). we partition the full sample using S&P Issuer Bond Rating data (Compustat item 280).

. the mean and median of AIS are. we report the estimated coefficients for the test variables (i.422).g.e.697). AA+ and AA are assigned a value of two and three. respectively. 135 and 87 basis points for the combined sample. we recode S&P Issuer Bond Ratings from AAA to D or SD by assigning a value of one if a firm is rated AAA and increasing the numerical rating value by one as the rating decreases by one notch (e. our results suggest that while the value of credit rating 12 When S&P Issuer Credit Ratings are involved in our analysis. Note also that the coefficient on Rating is significantly positive across all three samples. and so on)..275). respectively. for the combined sample of both investment-grade and non-investment-grade firms.697 observations since many firms in our sample have no values of Issuer Credit Ratings. Rating). The mean and median differences between the two investment-grade and noninvestment-grade sub-samples are highly significant. In addition.. taken as a whole. Moreover. The decrease of sample size may weaken the power of our tests. In so doing.borrowers with their S&P Issuer Bond Rating of BB+ or below (N = 1.. for brevity. the coefficient on Big is significantly larger in magnitude for the non-investmentgrade sample than for the investment-grade sample. and for the non-investment-grade sub-sample respectively. and 248 and 225 basis points for the non-investment-grade sub-sample.24 - .e. indicating that banks charge a significantly higher loan spread for firms with non-investment grades than for firms with investment grades. Big and Tenure) and the partitioning variable (i. for the investment-grade sub-sample. 12 We then estimate Equation (1) after including the Rating variable as an additional independent variable. 13 Though not reported in Table 9. suggesting that the loan spread increases as the credit rating becomes downgraded. the coefficients on Big and Tenure are highly significant for the combined sample (N = 3. 71 and 50 basis points for the investment-grade sub-sample. The above results. As shown in Table 8.422). indicate that the value of high-quality audits in the context of bank loan pricing is more pronounced for borrowers with high credit risk than for borrowers with low credit risk. 13 In Table 8. but they are insignificant for the investment-grade sample (N = 2. the sample reduces to 3. separately. The same coefficients are highly significant for non-investment grade firms (N = 1.

Second. in particular. (Insert Table 8 here) SUMMARY AND CONCLUDING REMARKS While previous auditing research has examined the role of audit quality in the equity and/or bond market.25 - . suggesting that banks view auditor tenure as a . To fill this gap. when banks assess the credit quality of borrowers with poor credit quality. namely auditor quality and tenure. respectively.information offered by credit rating agencies is useful for banks to assess borrowers’ credit quality (as reflected in the highly significant coefficient on Rating). Our results show that banks charge a higher loan spread for borrowers who change their auditors in general. on the price term of bank loan contracts. The results of our multivariate tests indicate that the loan spread difference between borrowers with Big 4 and non-Big 4 auditors are about 32 and 49 basis points for the full sample and the non-investment-grade sub-sample. we find that the loan spread charged by banks is significantly lower for borrowers with prestigious Big 4 auditors than for borrowers with non-Big 4 auditors. Further analysis suggests that banks view the auditor switch as a credit risk-increasing event. we find that banks charge a lower loan spread for borrowers with long-tenure auditors than for those with short-tenure auditors. These differences are economically significant as well. the value of audit quality in bank loan pricing is not subsumed by the value of credit rating information. and they charge a substantially higher loan spread for borrowers who downgrade their auditors from Big 4 to non-Big 4 auditors in particular. we investigate the effect of two auditor characteristics. it has paid little attention to the role of audit quality in the market for private debts such as bank loans. We perform our analysis using a large sample of US bank loan data over the 9-year period from 1996 to 2004. Our results can be summarized as follows: First.

26 - . loan size. In conclusion.credit risk reducing factor. we find that the loan spread-reducing effects of auditor quality and tenure are greater for non-investment-grade firms than for investment-grade firms. our study provides direct evidence that banks take into account audit quality when assessing borrowers’ credit quality and determining the loan spread. In particular. This suggests that high-quality audits are of greater value to banks when borrowers have lower credit quality. We leave this issue to future research. Third. However. Warranted is further research on the effect of audit quality on the non-price terms of loan contracts. loan maturity and other loan-specific characteristics. Our results provide new insights into the role of audit quality in the private debt market. we find that the relations between the loan spread and auditor quality and between the loan spread and auditor tenure are conditioned upon the level of credit risk perceived by credit rating agencies. the results of our main regressions are robust to a variety of sensitivity checks. the price term is likely to be determined jointly with the non-price terms such as loan covenants. . Finally. Our study focuses only on the effect of audit quality on the price term of loan contracting. loan securitization.

Social Science Research Network. 2003. Hoyt. V. . Choi.. G. 2002. and G. Journal of Accounting Research 36: 57-70. J-H. and K. A. N. Social Science Research Network. Sharpe. Weber. Goyal. The determinants of contract terms in bank revolving credit agreements. 2000. Udell.. Detecting GAAP violation: implications for assessing earnings management among firms with extreme financial performance. and R. loan quality and bank risk. Accounting quality and debt contracting. 1999. 2005. Davis. 1997.27 - . The Accounting Review 78: 119-142.. B. and I. D. Sunder. Weber. M. B. D.. Property rights protection and bank loan pricing. F. Noland. Paterson. W. Berger. 2003.REFERENCES Asquith. Social Science Research Network. Raghunandan. and D. A. Working Paper. Bae.. A. Journal of Accounting and Economics 40: 101-128. 2002. Journal of Financial and Quantitative Analysis 35: 87-110. Schiff. P. Social Science Research Network. S. CPA switches and associated market reactions. I. Dichev. R. T. T. and A. Journal of Accounting and Public Policy 16: 271-309. D. M. Auditor tenure and audit quality: Evidence from going concern qualifications issued during 1996-2001. 2002. K-H. Working Paper. and G. Betty.. Working Paper. R. Auditor tenure and audit reporting failures. Soo. Beneish. Working Paper. S. Large-sample evidence on the debt covenant hypothesis. E. Blackwell. Dennis. 1990. Winters.. T. Auditor tenure. Performance pricing in bank debt contracts. J. and J. auditor independence and earnings management. Journal of Accounting Research 40: 1091-1123. S. Skinner.. Ex ante incentives for earnings management and the informativeness of earnings. and D. Trompeter. Journal of Business Finance and Accounting 26: 807-832. 1981.. Geiger. R. 2005. and J. Betty.. Journal of Monetary Economics 25: 21-42. Sunder. Doogar.. 2006. and S. The Accounting Review 56: 326-341. Bharath. A. E. Collateral.. L. Christensen.. Auditing: A Journal of Practice & Theory 21: 67-78. and J. The effects of debt contracting on voluntary accounting method changes. Nandy. 1998. Fried. J. The value of auditor assurance: Evidence from Loan Pricing. and V. D. D. M.

A cross-firm analysis of the impact of corporate governance on the East Asian financial crisis. Simunic. Audit reports and the loan decision: Actions and perceptions. H. Lins. 2002. E. D.Ghosh. S. Johnson. Journal of Accounting and Economics 37: 113-136. Pany. A. Fortin... and D. T. Myers. Working Paper. Voluntary audit and the cost of debt capital of privately held firms: Korean evidence. Journal of Accounting Research 42: 589-623. Exploring the term of the auditor-client relationship and the quality of earnings: A case for mandatory auditor Rotation. . Audit-firm tenure and the quality of financial reports. Working Paper. 2004. E. Auditor tenure and perceptions of audit quality. Maxwell. 2002. N. J. 2000. Kim. and D. 2003. Journal of Financial Economics 64: 215-241. __________. M. Mitton. 1999. Contemporary Accounting Research 19: 637-660. P. and C. P. Does auditor quality and tenure matter to investors? Evidence from the bond market.. W. Prentice Hall. Borrower risk and the price and nonprice terms of bank loans. I. and R. Miller. The Accounting Review 80: 585-612. The Accounting Review 78: 779-799. and T. K. and J.28 - . D. P. L. and valuation: Do analysts matter most when investors are protected least. J-B. Working Paper. Journal of Accounting Research 42: 755-793. Social Science Research Network. 1983. K. Econometric Analysis. Miller. A. K. Moon. Strahan. H. Auditor choice and the cost of debt capital for newly pubic firms.J. A.. 2004. Auditing: A Journal of Practice & Theory 2: 38-51. 4th ed.. Concentrated control. Greene. A. N. Pittman. Reynolds. C.. M. F. Myers. A. Social Science Research Network. 2006. White. and S. Upper Saddle River. 2004. 2005. Johnson. Yi. H. W. V. L. Omer. analyst following. and D. 2005. Lang. K. Khurna. Information risk and the cost of debt capital. University of Arizona. Mansi.. Stein. T.. J.

775 23.353 56.00 .18 Revolvers 450 484 402 419 429 496 477 530 666 4.96 All Facilities 628 686 705 778 851 972 965 1.29 - .000 1.528 19.TABLE 1 Sample Distribution by Year and Loan Type Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 Total Percent (%) Term Loans 133 137 183 212 176 188 214 237 295 1.047 7.86 364-DayFacilities 45 65 120 147 246 288 274 233 110 1.656 100.

656) Variables Big Tenure Size Leverage MB Current Ratio Log Coverage Ratio Profitability Tangibility Beta Loss Mean 0.540 0.753 1.000 Std.349 1.664 0.262 1.705 313.000 146.037 652.379 40.213 1.216 5.157 0.045 1st Quartile 62.000 45.980 2.007 0.215 2.000 8. Deviation 130.922 0.150 0.TABLE 2 Descriptive Statistics Panel A: Loan Facility Characteristics (N = 7.219 24.500 12.418 1.237 0.000 5.257 9.112 1.818 2.136 0.000 3rd Quartile 250.078 0.000 6.483 0.000 36. Deviation 0.286 0.969 0.000 2.177 0.000 1.086 0.385 0.182 0.509 1.590 1.893 0.000 Median 1.671 0.096 0.656) Variables AIS (Basis Points) Maturity (Months) Loan Size (Millions of US$) Syndicate Number of Lenders Mean 172.414 0.119 1.080 1.388 .775 0.240 1.929 9.201 1.000 3rd Quartile 1.157 1.051 1.30 - .000 12.951 8.184 1st Quartile 1.000 350.514 Panel B: Borrowing Firm Characteristics (N = 7.000 Std.000 Median 150.368 1.000 60.000 13.359 0.000 6.753 0.145 0.512 1.446 6.210 0.000 4.000 8.000 1.

06 -24.86*** -9.145 0.279 7.279 7.035 0.000 1.833 4.000 1.231 8.868 0.000 4.136 0.425 1.42*** -5.000 7. Non-Big Auditor Variables N AIS (Basis Points) Tenure Size Leverage MB Current Ratio Log Coverage Raito Profitability Tangibility Beta Loss Maturity (Months) Loan Size (Millions of US$) Syndicate Number of Lenders 7.51*** 12.924 0.279 7.92 -3.139 0.000 18.71*** 3.31 - .58 -1.836 0.182 40.134 1.66*** -5.279 7.279 7.279 7.279 7.000 5.304 0.511 2.000 36.501 1.31*** .093 0.47 -0.290 0.769 Median 250.793 2.279 7.141 0.323 0.266 1.967 0.Big) t Z 11.301 2.012 0.279 Big Auditor Mean 168.430 68.33*** -8.000 Test for Difference (Non-Big .581 6.474 5.84*** -0.279 7.000 8.891 0.09 -4.748 3.00*** 16.175 0.65*** 1.174 1.771 326.938 9.279 7.20*** 4.279 7.279 7.215 39.58 -1.75*** -2.012 0.000 1.43*** -18.26** 1.279 7.541 0.000 N 377 377 377 377 377 377 377 377 377 377 377 377 377 377 377 Non-Big Auditor Mean 252.43*** -12.20*** -28.000 150.000 36.34 19.283 1.20*** 21.TABLE 3 Comparisons of Loan and Firm Characteristics Panel A: Big Auditor vs.279 7.54*** 10.000 6.95*** -0.04 -1.918 0.318 Median 150.766 1.654 2.351 1.246 1.177 0.235 0.40*** 14.11*** -2.68*** -10.

149 0.680 3.904 2.976 3.680 3.976 3.174 0.976 3.40*** 1.430 1.957 0.092 1.307 0. Short Tenure Variables AIS (Basis Points) Big Size Leverage MB Current Ratio Log Coverage Ratio Profitability Tangibility Beta Loss Maturity (Months) Loan Size (Millions of US$) Syndicate Number of Lenders Long Tenure (>=8 yrs) N 3.976 3.069 100.321 0.81*** -9.02** -19.960 0.680 3.913 382.976 3.663 200.18 -4.931 6.80*** -23.159 38.19 -1.258 1.680 3.01*** -8.23*** -2.39*** -7.05*** -12.266 1.73*** -3.74*** 0.976 3.680 3.000 7.000 0.680 3.976 3.146 0.413 1.07 -1.250 1.584 1.93 4.275 0.680 3.976 3.49*** 5.680 3.946 9.680 3.741 1.000 36.72*** -24.910 8.168 0.9642 1.000 200.265 0.680 3.000 5.139 0.10*** -6.000 Test for Difference (Short-Long) t Z 19.000 0.247 0.976 3.969 7.680 3.998 0.06 4.680 Mean Median 201.000 6.180 0.359 0.000 7.000 1.240 1.680 3.976 3.934 0.000 .89*** 7.144 0.00*** 6.338 1.49*** -1.00*** 6.887 0.976 Mean 145.000 36.43*** 5.976 3.455 1.000 Short Tenure (<8 yrs) N 3.TABLE 3 (continued) Panel B: Long Tenure vs.211 42.266 0.88*** -6.69*** -7.240 1.738 2.47*** 22.059 0.131 0.927 Median 111.680 3.83* 0.32 - .976 3.680 3.767 1.976 3.10*** 239.59*** -6.88*** 6.976 3.

07*** -0.39*** 1.11*** 1.10*** 0.14*** 0.05*** 0.23*** 0.07*** -0.00 0.04*** -0.03*** 0.26*** 0.15*** 0.54*** -0.57** -0.02 1.16*** -0.07*** 0.000 0.24*** 0. two and three asterisks respectively denote the significance at the 10%.01 -0.07*** 0. .12*** -0.07*** -0.00 -0.33 - .01 0.22*** 0.03*** -0.13*** -0.13*** -0.00 0.17*** 0.24*** -0.17*** 0.83*** 0.18*** 0.00 -0.46*** 0.00 0.00 -0.000 0.20*** 0.31*** -0.56*** -0.04*** -0.39*** 1.25*** 0.17*** 1.01 0.32*** -0.16*** 1.27*** -0.01 -0.17*** -0.18*** 0.05*** 0.01 1.02 0.00 -0.00 Big Tenure Log Maturity Log Loan Size Syndicate Size Leverage MB Current Ratio Log Coverage Profitabili ty Tangibilit y Beta Loss One.42*** 0.03** 0.38*** 1.00 1.09*** 0.01 -0.00 0.10*** -0.36*** 0.06*** 0.00 0.11*** -0.16*** -0.11*** -0.02* -0.15*** -0.15*** 0.06*** 0.06*** 0.10*** 0.09*** -0. 5% and 1% level in a two-tailed test.18*** 1.00 -0.12*** 0.07*** -0.01 0.19*** -0.20*** -0.16*** 0.01 0.02* -0.15*** 1.07*** 1.27*** 0.05*** 0.05*** -0.46*** -0.12*** 0.00 0.10*** 0.45*** 0.02** -0.01 0.02* -0.24*** -0.01 -0.14*** -0.00 0.03** -0.TABLE 4 Pearson Correlation Coefficients Variables AIS Big Tenure Log Maturity Log Loan Size Syndicate Size Leverage MB Current Ratio Log Coverage Ratio Profitability Tangibility Beta Loss AIS 1.06*** -0.16*** -0.06*** 1.02* -0.04*** 0.05*** 1.00 0.00 0.02** -0.06*** 0.07*** -0.

667 (-0.32) -16.381 (-1.70) -19.300*** (-5. and Other Control Variables Variable Test Variables Big Tenure Borrower-specific Characteristics Size Leverage MB Current Ratio Log Coverage Ratio Profitability Tangibility Beta Loss Loan-specific Characteristics Log Maturity Log Loan Size Syndicate Intercept and Dummies Intercept Loan Purpose Dummies Industry Dummies Year Dummies N Adj. The t-statistics in the parentheses are based on White (1980)’s heteroscedasticity-corrected standard errors.14) -100.47) -5.20) -33.268*** (-9.29) -16.78) -14. One.508*** (-3.68) -13.577** (-2.506*** (-11.26) -1.051*** (-9.58) -19.543*** (-4.635*** (22.02 8.00) -2.38) 92.52) Model (2) (1) (3) N denotes the number of observations used in each model.53) 18.TABLE 5 Full Sample Results of Regressions of Drawn All-in Spread on Auditor Quality.917 (-1.006*** (14.16) -2.52) -19.69) 8.38) -3.173*** (14.82 580.656 51.553*** (-12.641*** (-14.721*** (-14.181*** (22.84) Included Included Included 7.162*** (14.15) -100.98 587.656 51.67) 90.186*** (4.78) -15.44) -1. R-sq (%) 587.534*** (-4.57) -1.30) -1. 5% and 1% level in a two-tailed test.13) -33.285*** (8.28) -98.607*** (-14.343*** (8.510*** (22.820 (-1.433*** (10.11) -2.815*** (10.060*** (-9.54) -1.516*** (4.01) 8.47) 93.87) -15. Tenure.693 (-0.73) Included Included Included 7.68) 18.259** (-2. two and three asterisks respectively denote the significance at the 10%.21) -34.698*** (8.686*** (-4.653*** (-4.471*** (-3.306*** (-4.29) -16.267*** (-5.853*** (-11. 35 .267*** (4.59) 18.96) Included Included Included 7.804*** (-4.25) 58.847*** (10.525*** (-3.612 (-1.38) 58.656 52.73) -14.23) 58.42) -4.

80 Test Variables Big Tenure Size Leverage MB Current Ratio Log Coverage Ratio Profitability Tangibility Beta Loss Inverse Mills Ratio Borrower-specific Characteristics Loan-specific Characteristics Log Maturity Log Loan Size Syndicate Intercept and Dummies 4.273*** (-6.79) -36.777*** (22.589*** (-11.079** (-2.13) Included Included Excluded 9 51.048*** (14.44) Included Included Included 4.936*** (15.74) (5) Inverse Mills ratio included -44.366*** (8.03) -7.124*** (7.12) 8.96) -40.902*** (-10.16) -33.222*** (-13.07) (2) One facility per firm-year -16.966 (-0.47) 101.35) -1.57) -35.641*** (-4.141*** (-6.29) -2.966*** (11.084*** (8.45) 91.549** (-2.13) Included Included Included 7.30) 527.655 51.77) 17.49) -1.475*** (15.95) (4) One-year lags of test variables -11.309** (2.45) 95.546 (-0.18) 18.879 (-0.491*** (4.21) -14. .441*** (9.70) -124.563*** (-6.12) -1.68) (3) Fama-MacBeth regressions -18.478*** (-5.306*** (-5.60) -19.29) 52.60 0.00) -0. 5% and 1% level in a two-tailed test.99 Intercept Loan Purpose Dummies Industry Dummies Year Dummies N Adj.38) -121.121*** (-4.53) 18.30) 540.770*** (10.63) Included Included Included 5.285*** (-4.12) 88.01) 92.321*** (4.38) -14.557*** (-3.65) -19.399 (1.20) -1.56) -0.07) -14.956*** (23.99) -3.264*** (-5. two and three asterisks respectively denote the significance at the 10%.885*** (-4.27) -7.166*** (-5.26) 58.15) Included Included Included 7.251*** (17.03) 53.507 52.600 (0.81) -103.03 2.937*** (5.143*** (13.13) -14.249*** (-12.426 (-1.689*** (-4.757 (-1.764*** (-13.559 52.43) -4.416** (2.46) 58.093 (-0. The t-statistics in the parentheses are based on White (1980)’s heteroscedasticity-corrected standard errors.78) -140. R-sq (%) N denotes the number of observations used in each model.825 (-1.19) 15.TABLE 6 Results of Various Robustness Tests Model Variable (1) One facility per deal -14.648*** (-3.194* (-2.080*** (8.80) -19.23) -99.54) -1.51) -2.43) -13.50) 5.728*** (-9.95) -2.262*** (-5.836*** (-4.42) -15.62) 19.92) 586.801*** (-12.773*** (9.03) -14.181*** (-4.53 8.914 (-0.993*** (10.478*** (-6.36 - .685 (0.08) -1.442 (-0.74) -1.579*** (-8.715*** (7. One.640** (-2.53) -13.11) -2.220** (-2.880*** (-2.38) -16.96) -1.885 54.634*** (-7.75) -18.16) -17.82) -4.21) -13.111*** (8.639*** (-14.756*** (-8.623** (-3.189*** (-9.09) -34.476** (-1.13) 56.430* (-2.75) 602.942*** (17.77) 18.047*** (-4.56) 602.

20) 59.428** (-2.087** (2.974 15.76) 4.992*** (-3.22) 23.429 (1.383* (-1.01) 4.22) Included Included 2. two and three asterisks respectively denote the significance at the 10%.84 -30.014* (-1.64) 11.89) -8.921*** (-3.05) -2.330* (-1.675 (1.974 14.803** (1.62) Model (1) (2) (3) (4) Δ denotes a change from year t .33) 7.28 -9.48) -164.80) -9.04) -2.881*** ∆Loss (5.142 ∆MB (0.897** (2.19) 2.95) 37.834** (-2.96) Included Included 2.788*** (5.35) 19.879*** ∆Log Coverage Ratio (-3.575*** (-7.377 (1.638*** (-3.93) 27.27) -16.819*** (-3.559** (2.22) 0.72) 33.56) 12.09) 4.17) Changes in Loan-specific Characteristics ∆Log Maturity ∆Log Loan Size Intercept and Dummies Intercept Industry Dummies Year Dummies N Adj.14) 0.33) 39.153 (1.22) -148.131 (0.36) 79.93 -22.392 (1.974 12.440** (2.1 to year t.586 (1.05) -18.302*** (-3.08) -18.22) 23.24) -146.459*** (-4. 5% and 1% level in a two-tailed test.15) 37.23) Included Included 2.83) -9.974 12.32) 5.681*** (-7.05) 0.086 ∆Tangibility (0.TABLE 7 Results of Regressions of Changes in Drawn All-in Spreads on Auditor Changes and Changes in Control Variables Variable Changes in Test Variables Change Upgrade Downgrade ∆Big ∆NonBig Changes in Borrower-specific Characteristics -15.147 (0.300 ∆Beta (1.05) -2.515 (1.04) -2.400*** (5.254*** (5.28) 40.411 (1.422* (-1. N denotes the number of observations used in each model.29) 23.28) 24.157 (0.354 (0.02) 25.708 (1.159** (2.405** ∆Leverage (2.32) -10.97) 0. .467*** ∆Profitability (-4.390 (1.382 (1.82) Included Included 2.230** (2.886* (-1.93) 33. The tstatistics in the parentheses are based on White (1980)’s heteroscedasticity-corrected standard errors.84) 4.917** (2. One.671*** (2.46) -166.007* (-1.26) 21.51 -24.31) 2.37 - .37) 79.294* ∆Current Ratio (-1.684*** (-3.54) 60.609*** (-4. R-sq (%) -32.635*** ∆Size (-2.85) -8.

12) -0. One.38 - .05) 7.01) 17. 5% and 1% level in a two-tailed test.40) 3.922 (-0.683*** (-2.735*** (12.624*** (6.33 (3) Non-investment Grade -49.71) ----- N denotes the number of observations used in each model. Combined Sample -31.697 62.64) 1. The t-statistics in the parentheses are based on White (1980)’s heteroscedasticity-corrected standard errors.TABLE 8 Results of Regressions for Sub-samples Partitioned by S&P Issuer Bond Rating Variable Big Tenure Rating N Adj.92 Difference between (3)-(2) -57.889*** (3.642*** (21.375 (1.290** (-2.422 44.373*** (-3. two and three asterisks respectively denote the significance at the 10%.74) 2.368 (-1. .62) 9.595*** (-2.98) -0.91 (2) Investment Grade 8.37) -1.275 40.747* (-1.81) -0.68) 16. R-sq (%) (1) Full.