Borrower-Lender Cross-Ownership and Borrower Audit Quality

Abstract

SUMMARY We study the effect of borrower-lender cross-ownership on the demand for a borrower’s external audit quality in syndicated loan settings. Cross-owners, which are institutional investors who hold the equities of both the borrower and the lead lender of syndicated loans, have the ability and incentive to increase the economic benefits accruing to both contracting parties. We hypothesize that cross-owners demand high-quality audits of the borrower’s financial information as a delegated monitoring device to resolve the agency cost of debt and improve contract efficiency. Our evidence shows that cross-ownership is positively associated with higher borrower audit fees, our proxy for audit quality. We also find that the effect is more pronounced for larger loans. Overall, these results suggest that cross-owners view external audits to be a viable monitoring mechanism for improving overall debt contacting efficiency. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M42; M48.