Auditors and Relationship Banking

Abstract

This study examines whether a bank’s relationship with a borrowing firm’s external auditor through a shared client portfolio affects loan pricing. I find that when lenders’ portfolios are more concentrated in firms engaging a particular auditor, borrowers who engage that auditor enjoy lower spreads. This relation is only evident when the lender is the lead arranger who is primarily responsible for information gathering about the borrower. Tests suggest the reduction in information asymmetry facilitating these lower borrowing costs occurs via banks’ enhanced ability to interpret the audited financial statements when they have greater familiarity with the external auditor. My results are relevant to debt-seeking firms who should be mindful of their auditor’s relationship with prospective lenders, as well as regulators seeking to better understand how auditors can affect corporate financing outcomes.