Analysis Of The Auditor Reputation’s Influence On Corporate Debt Financing

The initial study motivation of this paper comes from a series of policy adjustments our country made in the debt market as well as the audit market. Our nation advocates consolidation of CPA firms to establish a high reputation in the audit market, at the mean time, it also promotes market-oriented reform of interest rates in the financial markets. Our country made it clear in2009that in order to form a rational distribution of accounting firms, we should focus on supporting10large accounting firms or so to accelerate the development. The active promotion of government departments and industry organizations triggered a new round of consolidation, which played a positive role in improving the overall reputation of this industry and promoting the formation of local high reputation accounting firms. Our country is committed to the development and construction of local brands, encouraging domestic firms to form their own reputation so that these firms can obtain a higher degree of market acceptance. On the other hand, People’s Bank of China expanded the floating range of loan interest for financial institutions in2004, the rates would be no longer based on the ownership or the size of enterprises, it enlarge the pricing power of commercial bank and improved the marketization of loan interest rates. The highest floating rage of rate was up to70%, while the downward floating range remained10%unchanged. In October, the People’s Bank of China decided to abolish the RMB loan interest rate cap. Due to the external governance of the audit, the author hope that we can enhance the efficiency of market investing and provide theoretical support and policy recommendations for the related parties by investigating the effects of high reputation auditor on debt market. Previous studies mostly focused on the role of audit opinions in debt markets. Few of them would think about how the auditor reputation would work in debt markets under situation of company with standard audit opinion. This article starts from the Chinese financial market reformation and inspects the effectiveness of the auditor reputation in the debt market. The author focuses on two major issues:first, what effect does the auditor reputation exactly have in the debt markets? Will this last long? Second, what will the role of auditor reputation look like when facing companies with different reputation and different nature of ownership?We discuss the definition of the high auditor reputation and its economic benefits in detail, then we analyze whether high auditor reputation can be on behalf of high quality audit, after all the debate in domestic academe never stops. The author deems that most domestic articles consider the high auditor reputation equals audit quality, while some scholars think the other way. But we realize that the Big4cannot be the representative of high auditor reputation in today’s audit market, there are also many excellent domestic CPA firms. Since that the Big4no longer has a monopoly advantage in the audit market, the author combine the local top-ranking CPA firms with Big4as the representative of high auditor reputation to examine its impact on the debt market. We believe these firms can provide a higher quality audit service. As high quality audit service is the most effective way to solve the problems in the contract as well as a better monitor of the company and it also can reduce the coefficient of earnings and improve the credibility of the financial statements. The companies who use their services can get the trust of the market easily, which has a significance meaning in the debt market.The author believes that the reputation mechanism in audit market can prevent the opportunistic behavior of the auditor and encourage auditors develop toward a higher level. High reputation has increased the credibility of auditors. As the audit market is a typical "lemon market", audit services as a commodity has dual characteristics of public goods and trust products, reputation mechanism will play an important role in the auditor market. If the capital market can respond to the auditor’s reputation, loan companies will take this opportunity hiring a CPA firm with high reputation to develop the information value of auditor reputation and audit opinions. On the one hand the high reputation auditors eliminate the pre survey costs before lending money and post monitoring costs for creditor against the debtor. Creditors do not have to assess the company’s business situation and evaluate the debtor’s credit themselves, they need not personally track the status of business operations management and project their capital invested. On the other hand, loan companies require high reputation auditors to prove that the company has investment value. When information asymmetry between the company and creditors depresses, debt pricing of the company will be reduced. Thus, the high reputation auditors build a bridge of trust between the creditors and loan companies, which help to reduce market transaction costs and improve operational efficiency of the market.However, auditor reputation is not the only thing that the debt market admits; creditors will consider the company’s credit history accumulated in debt market. The young corporate companies have a blank credit record in the debt market, so they need to "rent" the auditor’s reputation ensuring their financing. As time passed by, companies increase the availability of information in the market after years of operation and reduce the cost of information, they can gradually obtain the trust of creditors by accumulating credit history in years. Then companies will no longer need to "rent" auditor reputation. So the author believes that the company’s reputation will gradually replace the auditors’ to reduce debt interest costs in the debt markets. In a word, the influence of auditor reputation on lowering firms’ interest rates will subside with age. In addition, companies with a good reputation can reduce the interest rates themselves, so auditor reputation has less use for them to low the interest rates. If a company can get lower debt interest rates by their own ability, then the auditor reputation is unlikely to make a further step to decrease the debt interest rates under this circumstance.There is credit discrimination against non-state enterprises in China’s financial system. State-owned enterprises have "political association" that non-state enterprises cannot compare with, therefore these two different nature of ownership of enterprises in the debt market will be treated differently. Although China’s banks marketing level continues improving, the banks have not yet led to radical change as the main market due to institutional factors. Governments are still having the absolute control of the banks and financial resources in many areas. In this case, the decisions of either the bank or state-owned enterprises are heavily influenced by government action. Obviously, there is an financial monopoly in state-owned enterprises, they take the space for non-state-owned enterprises to get financing, which contributes that the non-state-owned enterprises not only have to bear with the problem of financing, but undertake a more expensive financing costs. Non-state-owned enterprises who subject to credit discrimination eager to hire high reputation auditors as a signal to get more from financial resources and reduce debt financing costs.In this paper, the author uses companies samples listed in A-share market from2009to2011. We found that:(1) high reputation auditor can reduce the company’s debt financing costs, the auditor reputation mechanism has been recognized of the debt market.(2) The marginal utility of the high reputation auditor is diminishing with the passage of time.(3) Comparing to the well-known company, the impact of high reputation auditor on corporate debt interest rates is more obvious in the general corporate.(4) The impact of high reputation auditor corporate debt interest rates is more obvious in the non state-owned corporate. However, this effect also subsides faster. While in terms of debt financing scale, employing high reputation auditors did not bring any significant advantages, auditors reputation mechanism doesn’t work.The main contribution of this paper is as follows:first, this article is based on China’s socialist market rather than Western tougher regulatory audit market, we examines the influence of auditor reputation. Previous studies are more about the impact of auditor reputation in the equity financing market but not the debt market, this article associated auditor reputation with the debt financing of companies to find out whether reputation mechanism can be recognized in debt financing market. Second, after a number of policy guidance and limitations in the audit market, the domestic CPA firms are gradually catching up with Big4. On2013AICPA audit firm rankings, Big4has been unable to stay at the head, so the author uses Big4and local famous CPA firms to check the high reputation auditor’s influence in debt market.The author hopes that this study can confirm that the effect of reputation mechanism in debt market has a positive inspiration and guidance for creditors and lenders. The financial market of our country still needs to be improved, but in the absence of the corporate governance structure and the perfection of the legal protection of investors, the reputation mechanism can make up for the lack of legal regulation, alleviate the information asymmetry problem between creditors and loan company. In the Future, the creditor may find reliable new investment projects, and loan companies can get lower interest rates. The recent reform of China capital market has entered a crucial stage and the audit market is a necessary step of efficient allocation of capital. The author’s research may enhance efficiency and provide supervisors empirical evidence to guide parties to the transaction.