Audit Quality of Big 4 Auditors and Credit Ratings －Focused on Non－listed Firms－
Asian Tax Journal Vol. 12 No. 3 (2011), pp. 275-306
Abstract
This paper investigates the effect of Big 4 auditors on credit rating and whether a relationship between earnings and credit ratings increases in non-listed firms. Prior studies suggest that large size of audit firms tend to provide high quality of audit service (Teoh and Wong 1993 ; Becker et al. 1998 ; Krishnan 2003 ; Behn et al. 2008). However, evidence on the effect of Big audit firms in Korea is still mixed and most results come from listed firms. For non-listed firms, market demand is relatively low and accounting environment is also quite different from that of listed firms. Therefore, market perception to audit quality of Big 4 auditors than non-Big 4 auditors will be different. In addition, costs and benefits from hiring Big 4 audit firms will be vary depending on a firm's incentives. Given the different conditions of non-listed firms compared to listed firms, a question on the effect of Big 4 auditors in non-listed firms is a testable empirical issue. And, if firms audited from Big 4 auditors are more likely to provide a high quality of financial information and credit companies believe that creditability of these firm's financial information is better than others, a association between earnings and credit ratings of firms audited from Big 4 auditors will be reinforced. This paper empirically explores these issues. Using a large samples 49,551 firm-year observations for the period of year 2005 to 2009 in non-listed firms, we test the effect of Big 4 auditors in terms of credit ratings. To do this, we use credit ratings from KIS-Value Ⅲ. Initially, 1 point represents firms with the best credit rank and 10 point represents firms with the worst credit rank. However, for the purpose of interpretation, we remark credit rank oppositely. That is, 1 point represents firms with the worst credit rank and 10 point represents firms with the best credit rank. Test variable in this paper is a Big 4 auditor dummy and a interaction variable between Big 4 auditors dummy and earnings. Other control variables such as return on assets, performance-adjusted discretionary accruals, size, leverage, change in cash flow, loss dummy, a fiscal year dummy, and industry and year's dummy are included in the credit ratings model. This paper finds the following results. First, firms received audit service from Big 4 auditors are more likely to have a good credit rating after controlling for other variables that affect credit ratings, Specifically, a coefficient on BIG4 is 0.282 (t=18.529) in OLS regression and statistically significant. This means that for non-listed firms, the effect of Big 4 auditors is significant and firms audited from Big 4 auditors are more likely to have a good credit ratings. Second, a positive relationship between earnings and credit ratings is pronounced for firms audited from Big 4 auditors than that of firms audited from Other auditors. This finding implies that creditability of financial reporting of firms audited from Big 4 auditors is considered as a positive signal to credit ratings. In addition, credit companies evaluate that earnings quality of these firms is better than that of firms audited from non-Big auditors. Our results are still robust in various sensitivity analyses such as Ordered Probit analysis and Newey and West (1987) methods. In sum, results of this paper suggest that even non-listed firms that beared relatively high audit fee, the effect of Big 4 auditors still exists and they enjoy a good credit ratings as a benefit from Big 4 auditors. So differential audit demand is working for non-listed firms. This effect may lead low cost of debt, because prior studies suggest that firms with good credit ratings are more likely to have low cost of debt. This paper has some contributions to related researches. The findings in this study has various implications. The results of this paper suggest that auditing services from Big 4 auditors provide a good signal in terms of credibility of financial information and affect credit ratings of non-listed firms. This finding is important in terms of showing that the effect of Big 4 auditors is significantly valid on even non-listed firms. More interesting finding of this paper is that a relationship between earnings and credit ratings of firms audited from Big 4 auditors is stronger than that of firms audited from non-Big 4 auditors, which means that receiving audit from Big 4 auditors gives a good signal about earnings quality in the market, specifically credit rating agencies. Therefore, these findings are very useful and provide a lot of important implications to regulators, investors and creditors that are interested in non-listed companies. Academics can also apply the discussion in this paper for related researches.
Keywords
- Auditor Size
- Big 4 Auditors
- Audit quality
- Earnings Quality
- Credit ratings
- Market's perception
- Non－listed firms
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