Expanded Auditor's Report Disclosures and Loan Contracting*

Starting in October 2013, auditors of premium-listed firms the United Kingdom are mandated to prepare an expanded auditor's report that provides details on audit procedures, risks material misstatement (RMMs), and materiality thresholds. This regulatory change is important study, because it aims increase informational value traditional, highly standardized, pass-or-fail report. We examine whether disclosures provide information relevant for adopting firms' loan contracting terms post-adoption period. Our results indicate introduction associated with reduced spread longer maturity facilities relative non-adopting UK firms. When we focus period, find number “unique RMMs” mentioned report, but not committee positively either or lenders syndicate. Additional tests show benefits, a spread, having lower accrue mostly adopters poor environment. Taken together, our preliminary evidence contain Kingdom. study highlights unique role providing supports standard setters' efforts enrich its content. Rapports d'audit élaborés et contrats d'emprunt Depuis octobre les auditeurs des principales entreprises cotées en bourse au Royaume-Uni sont tenus de préparer un rapport plus élaboré qui décrit procédures d'audit, risques d'anomalies significatives (RAS) seuils d'importance relative. Il est d'étudier cette modification réglementaire, car elle vise à accroître la valeur informative rapports d'auditeurs conventionnels, fortement normalisés type « réussite ou échec ». Nous examinons si renseignements divulgués dans le fournissent l'information pertinente relativement aux modalités ententes prêts assujetties règlement lors période suivant son adoption. Nos résultats indiquent que mise œuvre du associée marges d'intérêt réduites échéances longues pour facilités prêt par non Royaume-Uni. Lorsque nous attardons cours post-adoption, constatons nombre RAS uniques » mentionnés l'auditeur, mais pas celui comité positivement associé d'intérêt, prêteurs groupement d'emprunt. Des additionnels révèlent ce surtout dont l'environnement d'information piètre qualité bénéficient, sur plan réduites, fait d'avoir moins grand Ensemble, nos données probantes préliminaires indiquant contiennent fins La présente étude met lumière rôle jouent fournir soutient organismes normalisation enrichir leur contenu informatif. To enhance content regulators setters worldwide took steps require enhanced beyond traditional “pass-or-fail” model (IAASB 2015; PCAOB 2017). Kingdom's Financial Reporting Council (FRC) issued International Standard Auditing (ISA) 700, making first listed disclose such “expanded” Specifically, ISA 700 mandates London Stock Exchange (LSE) Main Market significant how procedures addressed these risks, thresholds used report.11 The adoption particularly important, FRC announced June only four months before mandatory Therefore, other settings, where new can be foreseen preempted by preparers through pre-adoption voluntary disclosures, instance unexpected. Several studies assess from equity market perspective (e.g., Gutierrez al. 2018; Reid 2019; Lennox 2021) mixed results. (2019) document higher earnings response coefficients period which suggests has participants. (2018) (2021), hand, do participants react attribute lack clear empirical characteristics setting, conducive finding perspective. pre-earnings announcements very detailed, as they consist complete financial statements well opinion (Gutierrez 2018). comprehensive nature investors likely incorporate this investment decisions at time announcements, consequently putting less emphasis annual information. By extension, may explain why seem use disclosures.22 Another potential explanation consistent findings stream research embedded setting filing dates databases Worldscope, Bloomberg) open sources largely unreliable 2021). In informativeness private debt market. potentially providers draw different payoffs their investments, also have risk preferences (Hasan 2014; Chiu Moreover, types investors, who rely mainly publicly available information, assign more importance (i) decision (ii) when estimating firm's future viability (Asare Wright 2012). one segment market, syndicated loans, loans borrowing firm obtains group lenders. Focusing auditing markets relatively limited (DeFond Zhang Baylis Additionally, represents major source capital worldwide—companies raise lending than public combined (Sufi 2007; Ferreira Matos relevance subject considerable academic debate. One literature advocates assists accurately borrower's credible quality accounting numbers (Blackwell 1998; Christensen 2014) transmits auditors' about creditworthiness borrowers (Chen 2016). contrast, another due lenders' access incorporated Cheng Carrizosa Ryan 2017; particular context least two ex ante asymmetries Ball 2008; Ivashina 2009; Bharath 2011; Fang 2016), between within syndicate Given wider scope includes additional regarding levels RMMs, could arguably cater needs implications contracting. motivates question, is: Is changes terms? second question relates cross-sectional differences More specifically, banks adjust sample firms, conditional posits characterized imperfect (Leland Pyle 1977) strong adverse selection problems (Jaffee Russell 1976; Stiglitz Weiss 1981), case general, particular. From pool applicants, attempt distinguish “good” high-quality (i.e., those repay loans) “poor” low-quality loans). screening process difficult disadvantage, incentives supply positive requesting financing 1977). overcome external parties perform initial determine much effort required diligence subsequent monitoring (Best 1993). Since face asymmetric payoff structure assessments focused downside (Bae 2013; Hasan Florou Kosi 2018), drives preference negative (Ball 2008). RMMs represent signal (Christensen 2014).33 part analyses common feature all policy proposals enhancing current (Lennox According joint description PCAOB, IAASB, FRC, convey sensitive practices decreases value. Consequently, if indicative into terms. We, therefore, formulate follows: Are RMM sets answer questions. differ following switch Based LSE two-year window around non-adopters, spreads maturities These attributable pre-post firms.44 line (2019), Alternative Investment (AIM) construct control (non-adopters), adopt typical experiences decrease average all-in-drawn approximately 38 basis points after robust using both shorter windows date placebo test, alternative difference-in-differences (DiD) designs, comparable US samples. However, none specifications association Overall, suggest had impact contractual, structural loans. solely relationship disclosed better gauge relationships, RMMs—that is, committee's report.55 See Appendix 1 examples non-unique RMMs. relation spread. 20 points. reliable supplemental analyses, obtain similar unexpected (or abnormal) consider lenders),66 concerned dealing fraud, management override internal controls, asset valuation, going concern, credit risk, goodwill impairment, IT failures. corporate governance, employ seemingly unrelated regression approach take account jointly determined. further relationships hold primarily poorer makes several contributions. First, contributes growing body Bédard Liao Zeng 2020; Minutti-Meza, 2021).77 Papers relying experimental design While Carver Trinkle (2017) unable useful, useful Kachelmeier Moroney 2021; Rapley 2020) reduce auditor liability judgments (Brasel Whereas 2021), France (Bédard 2019), Mainland China (Zeng 2020), Hong Kong (Liao best knowledge, ours empirically usefulness given prior consequences generalizable assessing respond call aware investigate influences grant (Ruhnke Boolaky Quick Both German banks' executive board members results; Ruhnke conditions, whereas (2016) not. Unlike studies, likelihood granting (private) loan, assesses contractual Second, complements recent examines Menon Williams 2016; Chen Francis Robin underscore For instance, while effects modified opinions cost covenants, debt. add emerging documenting Third, makers specific investors—providers Indeed, goal allow uncertainties inherent (Kelton Montague regard, some support (European Union IAASB Responding calls FRC) proposed replace recently implemented standards, should include responsibilities, applied during audit, used. most disclosure key matters (KAMs; 2015), critical (CAMs; 2017), (FRC 2013). Comparable KAMs CAMs, defined “[t]hose that, professional judgment, were significance period” (ISA 701, paragraph 8).99 As indicated (2018, 1548), “An requirement standards communicate (KAMs proposal) (CAMs proposal). Similar requirements assessment identified [RMMs] purpose CAMs work.” Kingdom, EU-Regulation No 537/2014 prescribes shall provide, among misstatement. Furthermore, according 701 (paragraph 13), matter was considered audit. IAASB's consultations issuing draft interested emphasized Basel Committee Banking Supervision (BCBS) stated “in process, improvements help improve overall management” (BCBS 2012, 1). & Poor's (S&P) highlighted “the disclosures…will create understanding issues meaningful analysts” “will enable users understand compare condition, results, cash flows peer companies” (Standard Rating Services 2). (UK Ireland) “The Independent Auditor's Report Statements.”1010 Statements” read together “Communicating Key Audit Matters Report.” requires companies present fiscal years ending 1, 2013. Besides including discussion explanatory concept reviews (2015, 2016) conducted implementation disclosures. 2016 review scope, perceived clear, concise, transparent, language reports move away generic descriptions generally, favor granular descriptions” 2016, 4). States, 2017, approved SEC 2017. standard, independence tenure. fully large, accelerated filers 30, 2019, December 15, 2020, companies. Syndicated lenders, finance Amiram involve parties, namely “lead arranger” lead lender) participating set-up, lender receives fee decide contract 2007). Best (1993), third-party and, depending assessment, require. If obtained generated sources, indicates borrower outlook, significantly efforts. come asymmetry lender. Despite lender's direct notwithstanding possibility established via previous interactions, always faces any agency (Jensen Meckling opportunistically secure favorable problem face. signing contract, know forthcoming (lack of) loan. costly firm, cannot actually observe it, thus creating shirks conducting thorough 2008).1111 acknowledge mentions instances (Carrizosa Nonetheless, scrutinize riskiness high serious concerns ability (Bharath Armstrong 2010; plays crucial reducing involved ways. screens processes performance, flows, probability periodic interest payment timely repayment hence default, estimate underlying collateral helps “less-informed” enabling them evaluate themselves hence, mitigate shirking diligence. recently, scholars demonstrated communicated purposes Minnis Although knowledge remains (Baylis does presented 2014), uncertainty incorporates alleviates being misled and/or exploited lender, Kim Song 2011). arguments apply “pass-or-fail model” 2012), affect assessments, ultimately, origination date. Current analyzing finds So why, would inform participants? “episodic” funds