Auditor Communication Provisions in Private Loan Agreements: Do They Matter?

Lin Cheng, Jacob Jaggi, Paul N. Michas, Jeffrey Schatzberg

Research output: Contribution to journalJournal

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Abstract

We examine auditor communication provisions (ACPs) in private loan agreements, which are private contracting mechanisms between external auditors and audit clients which establish communication between lenders and their borrowers' auditors. We provide evidence that lenders value privately-contracted auditor communication and often specify multiple ACPs that facilitate lender monitoring. In terms of debt contracting outcomes, we find ACPs are associated with a lower ex ante likelihood of loan covenant violation. We also examine audit fee implications for the borrower and find that ACPs are associated with higher audit fees, which is consistent with auditors responding to the litigation risk these provisions impose. We corroborate this by providing evidence that this relationship is concentrated in samples where the risk of third-party litigation is greater. Finally, we find evidence that ACPs lead auditors to become more conservative as their clients exhibit lower signed discretionary accruals when the risk of third-party litigation is greater.
Original languageEnglish
Number of pages52
JournalJournal of Practice and Theory
DOIs
Publication statusPublished - 26 Oct 2023

Keywords

  • Loan agreements
  • Auditor communication provisions
  • Information asymmetry
  • Auditor litigation risk
  • Audit fees
  • Auditor conservatism

Indexed by

  • ABDC-A*
  • SSCI

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