Spend Money to Make Money?: Voluntary Audit Reviews and Firms’ Cost of Debt

Abstract

An audit review (AR) is a mechanism used by boards to assess the quality of interim financial reports on a timely basis. In this study, we analyze whether the voluntary purchase of an AR reduces the screening costs of lenders and translates into lower cost of debt for borrowers. We use a sample of 8,021 firm-year observations from 1,678 public firms in Canada over the period 2004-2015 to test this prediction. The results suggest that firms with voluntary ARs have a lower cost of debt than firms with no AR. Further analyses using samples of public bonds and private loans corroborate our findings. Cross-sectional analyses suggest that, for borrowers with higher information asymmetry, the impact of voluntary ARs is incrementally stronger only for public debt. Our study is the first to document that the voluntary purchase of ARs caters to lenders’ informational needs and benefits listed borrowers through a lower cost of debt financing.