Abstract
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 non-Big 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.
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