Auditor Industry Specialization, Credit Rating And The Cost Of Debt

The existence of information asymmetric and agency problem highlight the role of external auditor. Previous literature suggests that auditor plays two important roles in capital market as information intermediary and assurance provider. In this paper, we focus on the auditor industry specialization, and examine the correlation of auditor industry specialization, credit rating and the cost of debt.Existing evidence suggests that creditors need transparent and credible financial information to predict future cash flows accurately and reduce information asymmetry. Measuring the quality of financial information seems to be difficult. So investors may rely on indirect indicators, such as audit quality. Previous literature support the positive correlation between audit quality and the quality of financial disclosures. And on average, industry specialization signals a higher audit quality. So we believe that industry specialization helps reduce information asymmetry risks, so as the cost of debt. Credit rating is an evaluation of default risk made by an independent third party. The higher the rating, the lower the cost of bond. Provided that credit rating relies on financial information to some extent, we believe that industry information will affect the relationship between credit rating and cost of debt. In addition, there are two separate bond trading markets and corporate bonds can be listed cross markets. We deduce that information risks of cross-listed bonds are lower than that of bonds issued in a single market, so the effect of industry specialization and credit rating on the cost of debt will be different.We use yield spread as the proxy of firm’s cost of bond. We calculate auditor’s industry market share to define industry specialization. Our results suggest that, compared to non-industry specialists and low rated, firms’cost of debt are lower if they are clients of industry specialists and high rated. Moreover, the cross variable of industry specialization and credit rating show that credit rating has a higher correlation with the cost of bond if the auditor is industry specialized. In addition, given the effect of cross-listing, we find that the correlation between industry specialization and cost of debt, the correlation between credit rating, and the impact of industry specialization on the correlation between credit rating and cost of debt are different between cross-listed bonds and non-cross-listed bonds, which reveals that cross-listed bonds and non-cross-listed bonds have different levels of information risks.