An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Jeong - Bon Kim
The Hong Kong Polytechnic University

Byron Y. Song
The Hong Kong Polytechnic University

Judy S. L. Tsui
The Hong Kong Polytechnic University

Abstract: Using a large sample of US bank loan data from 1996 to 2004, we investigate the effect of auditor quality and tenure on bank loan pricing. Our results show the followings: First, banks charge a significantly lower rate for borrowers with prestigious Big auditors than for borrowers with non-Big auditors, and banks charge a higher loan spread for borrowers who change their auditors in general and especially for borrowers who downgrade their auditors from Big to non-Big auditors. Second, the loan spread is inversely related to auditor tenure, and this inverse relation is piecewise linear in that the relation is much stronger for borrowers with relatively long-tenure auditors. Third, we find that the relation between loan spread and audit quality is conditioned upon leverage ratio, credit ratings and analyst following. 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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