Auditor Choice and the Pricing of Initial Public Debt Issues

Abstract

We examine the importance of auditor choice to the pricing of debt initial public offerings. These securities raise information asymmetry by expanding firms' debt ownership structures to include public bondholders and by extending debt maturity. Prior research on initial equity issues has had difficulty discriminating between two motives for choosing a Big Five auditor: reducing the uncertainty about firms' financial statements and providing greater implicit insurance coverage in the event of audit failure. Results from separately estimating the impact of auditor choice on the perceptions of credit rating agencies and bondholders suggest that initial bond pricing is driven by both information and insurance incentives, with each responsible for lowering at-issue yield spreads by about 19 basis points, on average. We also report evidence consistent with the prediction that firms intending to replace bank debt with public debt, which reduces cross-monitoring among lenders and increases default risk according to extant research, benefit more from hiring a Big Five auditor.