The Impact of Accounting and Audit Quality on World Bank Lending Decisions

Abstract

We investigate the role of accounting and audit quality differences across countries in the allocation of international development aid. Such aid is crucial to developing countries and enables them to improve governance functions, infrastructure, and create more efficient business and capital markets. The accounting and audit environment in a country is a major characteristic that, if relatively strong, can provide donors with some confidence that development aid is being used for its intended purpose rather than being subverted for personal or political gain. We find that development loan aid (as a percentage of a country's GDP) is higher in countries with higher accounting quality. We also find that this relationship exists both before and after a country adopts International Financial Reporting Standards, but less so in the post-IFRS adoption period. Further, we find that loan aid is higher in countries where the audit environment provides a foundation for higher-quality auditing, both in countries that use IFRS as well as countries that use their own domestic accounting standards. Finally, we find that grant aid that does not require repayment by the recipient is not associated with accounting or audit quality. In these cases, the possibility that higher accounting and audit quality is able to prevent the diversion of aid away from its intended targets is overwhelmed by the importance of providing support that is often targeted directly towards saving lives.