The Value of Attestation by Public Accountants: Evidence from Loan Pricing

Abstract

There is little direct empirical evidence on the value of having financial statements examined by independent accountants or on whether the benefits of attestation vary with degree. The purpose of our paper is to provide evidence on both of these issues by examining how interest rates charged on bank loans vary with the amount of attestation purchased by borrowing firms. We use a sample of loans to small, private companies that are not required by regulation to purchase audits. Our paper studies one potential benefit of attestation, that of reduced interest rates on bank loans. We address the following question: Given the loan officer's decision to grant the loan, does the level of attestation affect loan pricing? To answer the question we estimate cross-sectional regressions of loan interest rates. We include dummy variables for the levels of attestation in the regressions as well as variables to control for credit risk and other relevant characteristics of the loan contract. The coefficients of the dummy variables provide estimates of the interest rate differences across attestation levels. We also conduct statistical tests for differences in interest rates across the four levels of attestation. Finally, we investigate how the interest rate savings of audits vary with the size of the firm and the amount of the loan. We find that firms providing audited financial statements pay lower interest rates on their bank loans than those providing reviewed or compiled statements, or those firms compiling their own statements, ceteris paribus. Loan interest rates are not, however, significantly different among firms providing reviewed, compiled, or unattested financial statements. We estimate that the purchase of an audit saves a company with total assets of $1 million approximately 37 basis points annually on the loan rate, compared to the lower levels of attestation. This benefit of the audit decreases with firm size. For example, a company with total assets of $5 million saves only 11 basis points. Audited firms with greater than approximately $10 million of total assets actually pay higher loan rates than unaudited firms, but the larger firms enjoy more external benefits of the audit which are not reflected in the loan rate.

JEL Classification: M41, M49, G21