Audit Regulation and Debt Financing: Evidence from PCAOB International Inspections

Abstract

We examine how audit regulation affects a non-US listed firm’s debt financing by exploiting the staggered introduction of the Public Company Accounting Oversight Board’s (PCAOB) auditor regulatory oversight of foreign audit firms from 2005 to 2017. We find that clients of auditors who are subject to PCAOB international inspections increase their propensity to issue public debt (i.e., bonds) rather than private debt (i.e., bank loans) after controlling for other determinants of the choice of public versus private debt. We also find a differential impact of PCAOB inspection access on the cost of debt, with a more significant decrease in the cost of public debt than private debt for countries that allow PCAOB inspections. Cross-sectional tests reveal that the effects of PCAOB auditor regulatory oversight depend on the importance of a borrower’s home country bond market and the institutional mechanisms that mitigate the agency costs of debt. Additional analyses using a sample of PCAOB inspection reports show that ex ante threat to auditors dominates the ex post effect for clients of the inspected auditors, and PCAOB inspection access affects loan contracts by encouraging fewer and loosened covenants. Collectively, these results suggest a spillover of audit regulation to non-U.S. listed firms that affects the firm’s choice of debt instruments, cost of debt financing, and the private debt contract design.