The Effect of Abnormal Audit Hour on Credit Rating and Cost of Debt
Asian Tax Journal Vol. 15 No. 5 (2014), pp. 9-55
Abstract
This paper investigates the effect of audit effort (abnormal audit hour) on credit rating and costof debt. Previous studies suggest that there is the positive relation between abnormal audit hourand quality of earnings (e.g. Caramanis and Lennox 2006；Park and Choi 2009 etc). Therefore,the auditor’s audit effort is important determinants of perceived audit quality. Auditorsindependently provide reasonable assurance on manager－prepared financial statements and candiscover and report breaches in a client’s accounting system. As such, audit quality contributes tothe credibility of financial disclosure, and to the reduction of cost of capital (Watts andZimmerman 1986). In addition, because investors often use audited financial statements as thebasis for asset－allocation decisions, securities laws provide recourse for the investor against theauditor. The purpose of this paper is to investigate whether credit rating agencies and credit loanagencies regard abnormal audit hour as audit quality. Therefore, we test the relation betweenabnormal audit hour and credit rating or cost of debt. The audit effort is measured in estimates ofabnormal audit hours, and in raw audit hours. For empirical analyses, we collect 6,441 firm－yearobservations from the companies listed in Korean Stock Exchange over the period of year 2004to 2010. Findings of this paper are following. First, there is the positive relation between abnormal audithour and credit rating. This proposes that credit rating agencies regard audit efforts as auditquality and reflect audit efforts when they decide credit rating. But auditor size (Big 4 auditors)is not related to credit rating. Second, there is not relation between abnormal audit hour and costof debt. This suggests that credit loan agencies don’t regard audit efforts as audit quality anddon’t reflect audit efforts when they decide cost of debt. But auditor size (Big 4 auditors) isrelated to cost of debt. In sum, the results of this paper indicate that credit rating agencies regard abnormal audit houras audit quality and reflect abnormal audit hour in credit rating. This results, however, indicatethat credit loan agencies regard auditor size as audit quality and reflect auditor size in deciding cost of debt. Therefore, these findings of this paper are very useful and provide a lot of importantimplications to regulators, investors, credit rating agencies and creditors that are interested in auditquality. Academics can also apply the discussion in this paper to related future researches.
Keywords
- Audit effort
- Abnormal audit hour
- Audit quality
- Credit rating
- Cost of debt financing
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